When you decide you need to hire someone, one of the big dilemmas business people face is do you hire them as an employee or do you hire them as an independent contractor? Unfortunately for the business owner, making the wrong choice can be costly. People hired as independent contractors are not subject to Social Security, Medicare, unemployment taxes, or any Federal (or State) withholding from the employer’s side. The individuals themselves are responsible for all those taxes. Thus, the IRS tries to keep a very close eye on businesses that classify workers incorrectly as, while sometimes the business is not aware of the parameters involving the classification, just as often the business is misclassifying them simply to avoid the expense of the tax consequences. As we have noted in previous Advi$ors, in the past few years, the IRS, with full support of Congress and the current administration, has stepped up enforcement of accurate worker classification as they work on collecting payroll taxes government officials feel are due.

If the IRS determines that you have classified your workers as independent contractors when they should have been employees, you can be subject to all back taxes due as well as interest and penalties on those taxes. The Dept. of Labor may also become involved as overtime might also come into play. As you can imagine, while many business people think they may be saving money by using the independent contractor classification, the IRS’s diligence in this area can result in significant additional costs due to the fines and penalties.

How do you judge the difference between an employee and an I.C. In the simplest terms, it often boils down to a control issue; How much control does the business have over the individual(s) they have hired to do the work? If you have a certain degree of control, the individual is an employee.  For example if you tell them what hours to work and/or track their time on the job, they are an employee. If you provide them with tools to do their job, most likely they are an employee. The following link points to an IRS page that will provide you with detailed guidance as to how to classify your workers: Classification of Workers. There is also great deal of information on the web in general concerning this subject because of all the issues and confusion surrounding the topic and the potential liability.

Be aware of situations where an individual works for you during the day as an employee and then as a supposed independent contractor “after hours”. Issuing a 1099 and a W-2 to the same individual in the same year raises a red flag to IRS officials. Make sure you can truly justify that classification of independent contractor for that “after hours” work.

While the use of independent contractors can be beneficial for your business, be aware of the regulations regarding the classification of workers and the serious consequences of failing to comply. While you may have no bad intentions, the regulating bodies generally have no sympathy for ignorance of the law. The IRS considers misclassification as payroll tax avoidance.  ( See Article ) While you may think you are making a good business decision, misclassifying your workers may be one of the most expensive, incorrect decisions you can make. We read about companies who make such decisions, and the associated costs, every week. If you have any doubts about how to classify your workers, please give us a call. We would be glad to help you in the determination.