Have you recently taken the time to see if your subcontractors are still eligible independent contractors? Or, are you an independent contractor wondering if you should be classified as an employee? Both are common questions asked every day by business owners and self-employed individuals.
Below are some key factors used to decipher between an independent contractor and an employee.
- Behavioral Control
- Behavioral control relates to the type of instruction given and the degree of that instruction.
- Independent contractors have the ability to direct and control their work, employees typically do not.
- Behavioral control can also include evaluation systems and/or job training. If those programs are being offered to you, your relationship is most likely employer-employee.
- Financial Control
- Financial control looks at who made the investment into the project and who will make a profit or loss from this investment.
- Employees are typically not subject to profit and loss opportunities, whereas independent contractors can be.
- Independent contractors are more likely to have unreimbursed expenses, significant investment in equipment, materials and other supplies used.
- Independent contractors are also free to advertise and seek out other business opportunities.
- Type of Relationship
- When evaluating the type of relationship two parties have, the IRS is not required to follow any written contracts between the organization and the individual. Instead, they will look at how the two parties work together and the roles they play within the business.
- If the relationship is seen as a more of a permanent relationship, this relationship would generally be classified as an employer-employee relationship.
- If the worker plays in an important role within the business the worker is more likely an employee vs an independent contractor.
One must look at all factors when identifying the relationship between two parties. Some factors may point toward an independent contractor while others may point towards an employee. If you don’t feel confident in deciding whether to designate someone as a contractor or employee, you can also choose to ask the IRS to make that determination by filing form SS-8. The SS-8, when filled out correctly, provides the IRS will the information needed to issue a formal determination on that particular relationship, keeping you in the clear should any audit or inspection be undertaken down the road.
Additional rules for Massachusetts based businesses
Massachusetts based businesses and workers should know the differences between federal and state laws. Massachusetts an additional set of factors and also has more severe penalties. In Massachusetts an independent contractor must:
- Be free from control and direction in connection with the services performed.
- Perform services outside the usual course of business of the employer.
- Be customarily engaged in an independently established trade, occupation, or profession of the same nature as the serviced performed.
So what happens if a business misclassifies an employee as an independent contractor?
The business may be liable for back taxes including FICA and unemployment tax. There is a safe harbor in place protecting some employers, §530 of the Revenue Act of 1978. Section 530 relief prevents the IRS from retroactively classifying independent contractors as employees, avoiding back federal employment taxes, penalties and interest. In order to qualify for §530 of the Revenue Act of 1978 an employer must:
- Have reasonable basis for treating the worker/s as independent contractors
- Consistently treat the worker and all other similar workers as independent contractors
- Filed all required form 1099’s for all applicable tax years
It is important to make sure you are filling all appropriate documentation when dealing with independent contractors. If you need more information in determining the status of a worker or the filing requirements of independent contractors please contact us.
Written by Melissa Rizzo
SECTION 530: ITS HISTORY AND APPLICATION IN LIGHT OF THE FEDERAL DEFINITION OF THE EMPLOYER-EMPLOYEE RELATIONSHIP FOR FEDERAL TAX PURPOSES
Instructions to Form SS-8
IRS Small Business article; Independent contractor vs Employee