Employee vs. Contractor – What’s the Big Deal?

Contractor or employee? It’s a decision that can have a significant impact on your business, so it’s important to examine whether the people you pay are classified correctly. Below, Davis shares three reasons why it’s so important to ensure the people you pay are classified correctly.

1. More Than Just Taxes?  Think it’s okay that you are paying that intern directly (and that they likely aren’t claiming those amounts on their taxes) or that your tax preparer has told you that your contractors should really be employees. It’s too much of a hassle, right? And if you get caught, you’ll just pay a bit more in taxes, right? WRONG. Although the IRS is one of the biggest government entities that may come after you for classifying your workforce incorrectly, they aren’t the only one. Many states worker’s compensation and unemployment divisions can tack on penalties and increase rates for companies and individuals found to have improperly classified staff. The money you may save now in payroll taxes might be dwarfed in the future by fees, penalties and ongoing higher insurance rates.
2. How Will You Get Caught? Business owners often fall into two categories – those who worry too much about an audit, and those who think it will never happen to them. No matter which camp you fall into, an IRS or state agency audit may not be the only way your misclassification is discovered. Often someone who worked for you as a contractor will decide to apply for unemployment benefits, and the funds will not be available. Or your state agency will not just deny the applicant’s claim, but will do some investigation into whether your failure to pay this person as an employee was correct (and more often than not, they will find that it wasn’t).
3. So What Makes an Employee? Wondering how on earth you are supposed to know whether someone should be a contractor or employee? Generally, the IRS and other agencies will look at the level of control you have over the potential employee and their work (do you say when they should be there, where they will perform the work, do you own the tools used, etc.) to make that determination. The IRS has some good material to help employers determine whether someone is a contractor or an employee, as does the Freelancer’s Union (though this information is geared to the contractors, it provides a good summary of what governmental agencies look for in this area). Another resource can be your tax preparer, accountant or attorney. If someone is in the grey area between employee and contractor, often your professionals can help you create the necessary documentation (contracting agreement, licenses, etc.) to create the relationship each party desires.

Nothing replaces an actual consultation with a good advisor regarding the correct classification of your workforce, but hopefully the above information makes it clear—this is a decision that can have a very significant impact on your business, so it’s one you should take some time with. And as always, let us know if we can help you!