One of the most common questions business owners face is whether a worker should be classified as an employee or an independent contractor. While the distinction may seem straightforward, misclassifying workers can lead to significant tax liabilities, penalties, and compliance issues.
The IRS and state agencies do not allow employers to simply choose whichever classification is most convenient and unfortunately, the worker's title, a signed contract, or even the worker's preference does not determine how they should be classified. Instead, the classification depends on the actual working relationship between the business and the worker.
What Does the IRS Consider?
The IRS generally evaluates three areas:
- Behavioral Control: Who controls how the work is performed?
- Financial Control: Who controls the business aspects of the work?
- Relationship of the Parties: How do the parties interact, and what is the overall nature of the relationship?
While no single factor determines classification, certain warning signs may indicate that a worker should be treated as an employee rather than an independent contractor.
Five Common Red Flags
Here are five common red flags that may indicate your independent contractor should actually be classified as an employee.
1. You Set Their Schedule
If you require a worker to work specific hours, be available during certain times, or request permission for time off, the relationship may be leaning toward employee status.
Independent contractors are generally hired to produce a result and often determine their own schedules.
2. They Work Only for You
Contractors frequently have multiple clients. If someone works exclusively for your business for an extended period, agencies may question whether they are truly operating an independent business.
3. You Provide Their Tools and Equipment
Workers who rely on company-provided computers, equipment, software, supplies, or office space may appear more like employees than independent contractors.
4. You Train Them How to Do the Job
Independent contractors are typically hired because they already possess the expertise needed to perform the work. Extensive training and supervision can indicate an employment relationship.
5. They Perform Your Core Business Services
The closer a worker's duties are to the primary services your business provides, the more likely they may be viewed as an employee.
For example, a bookkeeping firm hiring a bookkeeper or a law firm hiring an attorney may face greater scrutiny than a business hiring an outside IT consultant or website designer.
The Bottom Line
There is no single test that determines whether a worker is an employee or an independent contractor. The IRS and state agencies evaluate the entire relationship and look beyond contracts or job titles.
If you're unsure how to classify a worker, it's best to review the arrangement before the first payment is made. A brief conversation today can help prevent costly payroll tax issues and compliance headaches later.
Need guidance? Contact our office before hiring a worker or issuing a Form 1099-NEC. We're happy to help you evaluate the facts and determine the appropriate classification.