Q. How do I know when to classify a worker as a contractor or a true employee?
A. Classifying a worker as an employee or a contractor has important implications for an employer’s administrative responsibilities.
An employer must withhold and pay an employee’s federal and state income taxes as well as Social Security, Medicare and unemployment taxes. For independent contractors, those requirements do not apply.
Moreover, an employer does not have to pay an independent contractor for overtime, nor does it contribute to a workers’ compensation fund in the event its contractor is injured on the job.
Unintended but incorrect classifications occur when, for example, a worker scales back hours while shifting from full-time to contractor status, yet still performs the same functions, or when a worker requests that a company hire his business rather than adding the worker himself to the payroll.
While an employer can save costs by classifying workers as contractors, the consequences of misclassification—whether intentional or not—are significant. An employer is liable for back wages and federal and state employment taxes, and may also have to pay retroactive benefits to the employee that he or she would otherwise have received. The IRS can impose penalties even for unintentional mistakes.
In addition, misclassification can trigger audits by the federal and New Jersey departments of labor and give rise to worker class actions for lost overtime pay.
In an effort to recoup missing revenue, both federal and state governments are cracking down on misclassification.
For example, the IRS is auditing 6,000 randomly selected businesses over a three-year period to determine whether workers classified as independent contractors should actually have been treated as true employees.
The IRS uses a multi-factor test that includes behavioral control (whether the business has the right to direct and control the worker), financial control (whether the business has the right to control the economic aspects of the worker’s job) and the type of relationship involved.
This last factor involves how the parties have worked together, the permanency of the relationship and the extent to which an employee provides services that are a key aspect of the employer’s business.
If a worker’s status is in doubt or in dispute, either the worker or the company can ask the IRS to make a determination by submitting form SS-8, available at www.irs.gov/pub/irs-pdf/fss8.pdf. The form’s checklist makes it a useful self-auditing tool as well.