The IRS is very interested in whether companies have properly classified their workers as employees or independent contractors. Why? Because if an individual is classified as an employee, he or she is subject to federal income tax and employment tax withholding when the wages are paid. This means the government gets their tax money right away. Wages and taxes withheld are reported via the Form W-2.
If an individual is classified as an independent contractor, the government isn’t guaranteed to get its federal income tax – the service recipient would have to report the income on a Form 1099 and the worker would have to report the income.
The IRS sees this as a big problem. Not all companies report income paid to independent contractors on a Form 1099 and not all independent contractors report income earned on their income tax returns.
How does a company know if a worker is an employee or an independent contractor? This is a very complicated area, and there is no hard and fast rule. Each situation must be reviewed to determine whether, based on the facts and circumstances, a worker is an employee or not.
The common law says that a worker is an employee if the service recipient (the company) has the right to control and direct the service provider (the worker). The control is not only over the results of what is to be accomplished, but also how the result is accomplished.
The IRS has relied on a 20 factor test to weigh how a worker should be classified. These factors generally fall into three categories:
- Behavioral Control
- Financial Control
- Relationship of the Parties
An analysis of all of these factors is outside the scope of this blog post. You should contact your attorney or accountant to help you determine the proper classification of your workers.
Law Offices of Debbie J. Cunningham
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