Employee or Independent Contractor: The IRS Wants to Know
The IRS has been cracking down on the misclassification of employees as independent contractors. Especially during tough economic times, employers looking to reduce expenses use contractors instead of full-time employees to save costs on payroll taxes, benefits and offsetting salary costs if there is not enough work at a given time. Some employers are using independent contractors as a way to stay beneath the 50-employee threshold for providing health insurance under the new health care laws.
Although these savings can be significant, the potential costs of the IRS reclassifying an independent contractor as an employee during an audit can also be substantial. Additionally, the cost of an IRS examination itself, including the disruption to your business, can also be quite expensive.
While the rules are far from clear cut, here are some questions to answer regarding independent contractor status:
- Behavioral Control: Does the company control what the worker does and how and where the worker does it? What level of instruction is provided to the worker?
- Financial Control: Does the worker have unreimbursed expenses incurred in performing their job? Are their services available to the general marketplace and are they free to seek other opportunities?
- Type of Relationship: Does the worker receive any benefits from the employer (i.e., insurance, vacation pay, etc.)? What is the duration of the relationship? Is there a written agreement?
While the answers to some of these factors may contradict each other, the relationship as a whole must be examined to determine the true nature of the relationship and whether the worker is properly classified as an independent contractor or should be an employee.
Employers should contact their tax advisor for assistance in making this determination or for representation during an IRS examination.