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If your business hires independent contractors on a regular basis as part of your normal business operations, then you are going to want to make sure that your worker classifications are correct. This can seem like a daunting task once you start to look through all of the federal and state determination requirements for classification as a contractor (Form 1099-MISC) versus employee (Form W-2), and the fact that federal and state requirements can also contradict each other can make it an even larger issue.
I’ve run an outsourced accounting and human resources firm for seven years and have employed a dozen amazing HR people who know their stuff. That’s how I know that not determining the proper classification from the start can have major consequences on your business operations, including additional employer taxes, penalties, civil fines, interest and other retroactive damages.
Definition Of An Independent Contractor
The IRS defines an independent contractor as: “a worker who individually contracts with an employer to provide specialized or requested services on an as-needed and/or project basis. This individual is free from control and direction of the performance of their work, and the individual is customarily engaged in an independent trade, occupation, profession or business.”
Compared to employees, contractors have greater control over how they carry out their work. Employers don’t need to withhold federal, state or local taxes for independent contractors, nor do they need to include contractors in their benefit programs. Contractors are also exempt from wage and hour laws, employment discrimination laws and unemployment insurance.
Even if all the duties are carefully spelled out in a signed contract between the two parties, it still may not be enough to make sure that the classification will hold up with state regulations that differ from the federal regulations of a true independent contractor classification, so make sure you are reviewing both federal regulations, including the IRS Common Law Test, and state regulations, like California’s ABC Test.
How To Determine Worker Classifications
There are a number of factors to consider when determining worker classification, but all federal and state factors need to be taken into consideration when deciding. Ultimately, the burden of proof is on the employer, and you should consider what is more beneficial for the employee, not the employer, when making this important decision.
Say you hire a software developer who will be creating a software package for a specific business not in the software industry. They can work off-site at their own place, use their own tools to create the software and make all the decisions when it comes to how, where and why to work on the project and provide the specially created software to the company. This worker would be considered an independent contractor.
On the other end of the spectrum, say a manager hires an intern to come into the office, be under the direct supervision of the manager and use company equipment to perform their duties. This intern has no authority to make decisions, has set part-time hours and works for minimum wage. This worker would not meet the classification of an independent contractor.
Helpful Implementation Tips
As you are hiring employees and independent contractors, here are some helpful tips that can be used to ensure that your classification processes are effective.
• Have policies and protocols in place for the hiring and use of independent contractors. This will prevent your company from using independent contractors in an attempt to circumvent paying benefits, which can cause classification problems for your business.
• Update your worker classifications as your business grows and changes. As your business has different needs, employees’ roles may shift, which can impact classification. Be sure that you keep this information updated.
• If you find that you have misclassified workers, then make sure that you correct the misclassification as quickly as possible. This may mean going back and paying them correctly and paying additional employer taxes to both state and federal agencies.
• Maintain updated knowledge about best practices for classification. Make sure that relevant stakeholders keep track of classification information at the federal and state levels to ensure your workers are classified appropriately.
Specific Examples By State
If you are a multistate employer, make sure you thoroughly read the language in all relevant state classification requirements, as they may seem similar but can be very different in their own way. Take, for example, the following two states.
California requires you to meet all three of the following:
• That the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; and
• That the worker performs work that is outside the usual course of the hiring entity’s business; and
• That the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
New Jersey requires you to meet all three of the following:
• The worker is free from control or direction over the performance of their services; and
• The services provided are either outside the usual course of the company’s business, or the services are performed outside of the company’s place of business; and
• The worker has an independently established business.
In New Jersey, the work has to be performed outside of the company’s place of business, whereas in California, it needs to be done outside of the usual course of the company’s business, so be careful that you are looking at wording at the state level as well.
By classifying workers properly, you can be assured that all your tax information will be filed correctly, reducing the likelihood of an audit. Whether you use the Common Law Test, the ABC Test or some other approach based on regulations, make sure that all of your workers are classified correctly so you can continue working toward your business goals effectively.
April 30, 2019 at 08:14AM
Forbes – Entrepreneurs