Are you sure you’re classifying… and paying… each of your employees correctly? The determination between whether an employee is a standard employee or an independent contractor has always been a source confusion and frustration. It’s essential for businesses to get it right, because the consequences can be costly. Fortunately, the IRS has some fairly clear guidance on how to differentiate the status all your workers, and if you aren’t up to speed yet, it’s important you keep reading!
Employees or Independent Contractor?
To answer the question “how do you determine if your worker is an employee or an independent contractor?” the government has given some guidelines:
- Behavioral: Do you control, or have the right to control, what tasks the worker performs, and how they perform those taskes?
- Financial: Do you control the logistical aspects of the worker’s job? IE, do you sign their paychecks, buy their tools/supplies, pay for their training and office space?
- Contractual: Do you have contracts or employee-type benefits with the employee? These could include a pension plans, insurance, and vacation pay. When they finish an assigned job, will they continue to work for you without needing to draft a new contract?
Evaluate each of your workers and use that information to see which category below they fit most neatly in. It might not be perfect, and that’s part of the difficulty.
The Five Different Types of Workers
The government recognizes five different types of workers:
Independent contractors offer their services to the general public – as in, anyone, including your competitor, can hire them if they’re not previously contracted elsewhere. A quick way to figure out if an individual is working as an independent contractor is to ask yourself the following question: am I paying them for only the result of their work? If the answer is yes, you’re most likely dealing with an independent contractor.
Employees. Under common-law rules, anyone who performs services for you is your employee if you can control what they’re tasked to do and how they perform that task. This is still true for even your most loosely managed employees. What matters is that you have the right to control the details of how the services are performed at your own discretion.
Statutory employees. In some cases, independent contractors that would otherwise be classified as such are to be treated as employees if they fall within certain categories and meet certain conditions. The categories for statutory employees are:
- Some Delivery drivers.
- Full-time life insurance sales agents who mainly sell life insurance or annuity contracts or both, primarily just for one life insurance company.
- Individuals who work at home on materials or goods that you supply.
- Full-time traveling salespeople who work on your behalf and turn in orders to you from wholesalers, retailers, etc.
You are required to withhold Social Security and Medicare taxes from the wages of these types of employees if all three of the following apply:
- The service contract states or implies that substantially all the services are to be performed personally by them.
- They do not have a substantial investment in the equipment and property used to perform the services.
- The services are performed on a continuing basis for the same payer.
Statutory nonemployees. There are three types of statutory nonemployees: direct sellers, licensed real estate agents and some companion sitters. Both direct sellers and licensed real estate agents are treated as self-employed for with regards to federal taxes – including income and employment taxes, but only if both of the following conditions are met:
- Payments for their services as direct sellers or real estate agents are entirely and directly related to their sales or other output, rather than to the number of hours worked.
- Their services are executed via a written contract stating that they will not be treated as employees for federal tax purposes.
The IRS also notes that independent companion sitters (those who are not employees of a companion-sitting placement service) are to be treated as self-employed for all federal tax purposes.
Government employees. These are generally treated like regular employees, and the government entity they work for withholds their taxes and issues an annual W-2.
So… are they Employees or not?
The IRS stresses that businesses must weigh all of the factors when determining how to classify their worker. Some aspects of their work may lead you to believe that the worker is an employee, and other factors may indicate that the worker is an independent contractor.
Unfortunately, the IRS says: “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.”
If this sounds confusing, you’re right! This article is just a summary, and there are quite a few more additional provisions and exceptions. Additionally, New regulations or lawsuits can change these classifications on a dime, and compliance is absolutely critical. We advise anyone reading this blog to work with a human resource professional to help them through the classification process if the answer is not clear to you.
Lost? We Can Help.
Capital Payroll can handle any type of payroll designation. Employee, contractor, commission only, full-time, part-time and seasonal. We can also give you the best resources to help you determine how to categorize all the workers in your workforce. We’d love to be your partner… so get in touch! You can call us directly at (804) 364-7220 or fill out the contact form below to get started.