HR professionals and small business owners must manage a vast number of compliance requirements, including employee classification. This issue has become increasingly tricky and potentially costly for businesses.
Incorrectly classifying employees as independent contractors is a real risk for many employers. An article from Forbes.com noted that,
"This fundamental worker status issue has become one of the most consequential legal determinations around. If you’re in business and guess wrong, the liability for past years can be crushing."
A recent report by the IRS Inspector General noted that many employers are still getting it wrong.
Mis-classifying employees can result in significant liability. According to a article from HRCalifornia,
"If your company controls the details and the worker does not have meaningful discretion in how he/she completes the work, it has generally been the rule that the worker will be found to be an employee and not an independent contractor."
In addition, state governments and the IRS are concerned about the loss of tax revenue when this occurs. According to a statement by J. Russell George, Treasury Inspector General for Tax Administration,
“This problem adversely affects employees because the employer’s share of taxes is not paid and the employee’s share is not withheld. If left unchecked, the problem will continue to deprive the Federal Government, and the American people, of millions of dollars in lost revenue every year.”
The IRS has, historically, provided guidelines to direct its agents on how to determine worker status. These guidelines include a list of 20 factors determined by the IRS and have been used in court decisions regarding worker status.
These are still used as guidelines and commonly referred to as the "20-factor test." However, some of the factors are less relevant today as they had been in the past. Currently, IRS agents are directed to focus on the overall situation rather than specific aspects of the 20 factor test.
According to the IRS rules, employee classification and a worker's status hinges on whether the employer has the right to direct and control the service provider on what is to be done and how it is to be done. Typically, an employer does control how an employee performs work. On the other hand, independent contractors will usually determine how their work is done.
Legal precedence and recent court cases have established three broad categories of factors for determining employee classification:
Do you, as the employer, have a right to direct and control how the worker does the task that you hired them for? Behavioral control factors include the extent of:
Does your business have a right to control the business aspects of the worker’s job such as:
Relevant facts regarding the type of relationship between you and the worker include:
While there may be many other factors to consider, these three provide the legal context for determining classification. This chart illustrates relevant points that an employer needs to consider when classifying an employee.
With the recent pressure being put on employers by both the IRS and various state agencies, it is critical that businesses be fully informed regarding the correct status and proper employee classification of all their workers.
According to the IRS website:
"Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor.
There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination."
If you are looking for reliable help with determining employee classification, we can help. Get your Free Download: Payroll Outsourcing Guide to help you make an informed decision or call Accuchex Payroll Management Services at 877-422-2824.