When you are looking to hire Independent Contractors, you want to make sure you are avoiding misclassification. A business that classifies its employee as an Independent Contractor but fails to meet all the regulatory requirements can be subject to a government tax audit or lawsuits.
The growth of Independent Contractors has increased by 40% in the last decade according to the Harvard Business Review. The Labor Department believes the reason so many employees are misclassified is the labor and workplace laws and companies are not knowledgeable about how to classify their employees. The issue of misclassification of Independent Contractors has been around for a while. According to the IRS, they view workers as follows: W-2 Employee, Independent Contractor, Statutory Employee (certain drivers such as dry-cleaning services) or Statutory Non-Employee (real estate agents).
In every business, you have your regular W-2 employees and standard procedure is for every paycheck, the company will take out payroll taxes and pays that amount to the IRS. At the end of the year, the employee will receive their W-2 and will then pay additional taxes to the government. However, when a business classifies an employee as an Independent Contractor (IC) It is a little different process with payroll taxes. These payroll taxes are paid on a gross amount and then the IC is responsible for making their own tax deposits to the IRS. The company is responsible for reporting the earnings to the worker and government. In turn, form 1099 will be sent at the end of the year.
The IRS has categorized three groups that will help determine if an employee is a W-2 or an Independent Contractor.
- Behavioral Control: Does a company control what the worker does and how they do their job?
- Financial Control: How is the worker paid? Do they do expense reimbursement?
- Type of Relationship: Are there written contracts or employee type benefits?
The IRS also created a 20 point checklist to help make it easier for people to determine. If you are involved with Independent Contractors and want to make sure they are meeting all IRS Guidelines, check out their website.