Understanding Employee vs. Contractor Designation

Whenever a company is looking to hire someone to perform work for their business, one of the questions that may be asked is whether the hire should be an employee or a contractor. Making the right decision can potentially save money for the business, but by the same token, could create legal issues and expensive penalties as well. Misclassification of employees as independent contractors can result in owing back taxes, back wages, business expenses, and more.

So what’s the difference between an independent contractor and an employee?

Independent contractors will generally be paid a flat fee based on the project or the hours worked, with no obligation for the employer to provide benefits such as healthcare or workers’ compensation. Income taxes are not withheld from independent contractors’ pay, and the employer is not subject to Social Security and Medicare taxes on these payments. The payment schedule can vary, based on the terms of the contract or when the contractor issues invoices to the business for payment. 

While this may sound like a cost-effective solution for a company’s hiring needs, the decision isn’t always up to the business. Both the IRS and the Department of Labor have some guidelines to help employers make the distinction between employees and contractors. Some key considerations include how much control the employer has over the actions of the worker, the permanence of the relationship, and who provides the tools and equipment necessary to complete the work. Some states may have their own tests to determine the proper classification of workers.

As a general rule, a contractor should not be performing the same work that an employee is doing. While there are some businesses out there who see the lower labor costs as an incentive to turn a blind eye to or even promote the misclassification of employees, it’s important to understand that this can lead to serious consequences. Since employers are not required to withhold and pay employment taxes on independent contractors’ pay, this may be construed as tax evasion or fraud, and the impacts of an audit or lawsuit can be devastating.  

Making the determination between employee and independent contractor can be a complex issue, and inadvertent or unintentional misclassification is not uncommon. The IRS does offer some support in these situations for qualifying employers. By meeting the requirements outlined in Publication 1976, Section 530, employers may be eligible for relief from federal employment tax obligations. The IRS also provides a Voluntary Classification Settlement Program (VCSP) that provides an opportunity for employers to reclassify their workers as employees for future tax periods. This may allow for partial relief from federal employment taxes by entering into a closing agreement with the IRS.

Trust an Experienced Human Resources Provider

Understanding the intricate details of worker classification and avoiding the costly errors that can be made when hiring workers for your company can be a daunting task without a knowledgeable HR professional at your disposal. Valor Payroll Solutions can provide you with the exceptional HR support you need to help take your business to the next level. Contact us today!

More To Explore