Some major companies have gotten in trouble with the IRS for confusing the two.
Full-time — and even some part-time — employees in the 1980s enjoyed a benefits bonanza. Health insurance, life insurance, pensions — new hires came to expect a lot in this department.
Not so much anymore. The cost of health care has skyrocketed, and the Affordable Health Care Act — no matter what your opinion of it is — has muddled the waters a bit for employers. Generous benefits are no longer a sure thing.
As you know, benefits are not an issue when you hire independent contractors. Many companies are increasingly looking at this option because of the rising cost of benefits. But the IRS has very strict rules about classifying individuals who work for you — and it enforces them. And the distinction goes beyond the basic benefits issue.
Knowing the Difference
According to the IRS, independent contractors are self-employed, and they must pay Self-Employment Tax. Employers can control the end result of the contractor’s work (The website design must be in by X, contain X content and meet the prescribed quality standards). They cannot direct the actual work habits of the contractor, or, “… how it will be done” (You must work between the hours of 9 a.m. and 5 p.m., dress a certain way, etc.) These individuals must fill out a Form W-9 at the beginning of the relationship, and they receive 1099-MISC forms during tax season.
Common-Law Employees, on the other hand, can be told by their employers what will be done and how it will be done. There are other characteristics, like whether there are written contracts or benefits and how the financial elements of the employee’s job are handled by the employer. Most employees fall into this category, and they receive W-2s.
There are two other classifications: statutory employee and statutory nonemployee. The IRS has established very specific conditions that must be met in order for individuals to fall into these categories. The professions that sometimes meet the specified criteria include licensed real estate agents, drivers, life insurance sales agents and full-time traveling salespeople.
The reason that the IRS is so precise about these classifications is because how you define someone who works for you mandates who pays what taxes. To muddy the waters more, even though the IRS has devised clear rules for worker classification, you may find yourself in the position of being uncertain because an individual has some aspects of each.
But don’t guess. We can help you apply the proper label so that taxes are submitted correctly and you’re not penalized by the IRS for improper filing of income taxes.