Misclassifying workers as employees or independent contractors has big implications for your business, including legal and financial risks that can hurt your business. It is essential for business owners to understand how to classify workers correctly, and the risks of not doing so.
How to Classify Workers
To determine whether someone is an employee or an independent contractor you must understand the relationship between the worker and your business. According to the Internal Revenue Service (IRS), an employee is someone who works for you regularly, follows your directions on how and when to do the work, and often uses the tools or resources your business provides. Employees also tend to receive benefits like health insurance or paid time off and pay taxes through payroll withholding. If an employer controls how the worker is paid, how expenses are reimbursed, and provides tools or supplies the worker should be classified as an employee.
On the other hand, an independent contractor is someone who works for your business on a project basis. They choose how, when, and where they perform their work, often using their own tools or materials and may work for multiple clients. They also pay their own taxes directly instead of having them withheld from their paychecks.
Please keep in mind that many states also have their own laws that establish an independent contractor relationship.
How Can Misclassifying Workers Affect a Business?
When workers are misclassified as independent contractors instead of employees the employer doesn’t pay their part of the taxes, and the worker’s taxes aren’t withheld. If a business makes this mistake, they can be held responsible for paying the taxes for that worker. Normally, employers withhold and pay income taxes, Social Security, Medicare, and unemployment taxes for employees. Misclassifying can also impact employee benefits, workers’ compensation, and unemployment insurance.
Voluntary Classification Settlement Program (VCSP)
If you mistakenly misclassified a worker, you could correct it through the Voluntary Classification Settlement Program (VCSP) offered by the IRS through form 8952. This program allows businesses to reclassify workers as employees without facing the full penalties of misclassification. The program requires employers to pay a reduced amount of back taxes and penalties, but it offers a way to correct the error without facing additional financial consequences.
When is Someone Considered Self-Employed?
Someone is considered self-employed if they have significant control over how their work is done. This includes choosing their hours and clients, as well as using their own tools or materials to complete the job. They often run their business under entities designating themselves as a sole proprietor, independent contractor, or a member of a partnership.
They are responsible for paying their own taxes usually through quarterly estimated tax payments. They also don’t receive benefits like health insurance, paid time off, or retirement contributions from the clients they work for.
People who do gig economy work are also considered self-employed. Such workers do short-term, flexible work as an independent contractor or freelance, often through an online platform such as Fiverr and Upwork.
In Conclusion
By understanding how to classify workers properly you’ll protect your business legally and financially. At UniqueHR, we understand the complexities of worker classification and the risk of misclassification. Reach out to us at 800.824.8367 for a free consultation.
