IRS and Independent Contractor Misclassification

Companies that misclassify employees as independent contractors could have the IRS demanding unpaid payroll taxes. The IRS looks at three broad categories in determining whether a worker should be classified as an employee or an independent contractor. The categories are:

Behavioral Control
These are facts that illustrate whether a company has the right to direct or control how a worker performs a specific task, including:
Instructions
Training

If a company has the authority to tell the workers what jobs they were to do and how and when they were to perform that work, these are factors that indicate employee status.

Financial Control
These are facts that illustrate whether a company has the right to direct or control how the business aspects of the worker’s activities are conducted, including:
Which party invests in work facilities used by the individual
Unreimbursed expenses
Method of payment
Opportunity for the worker to realize a profit or loss
Services available to the relevant market

Example: If the company has the right to fire the workers, who are an integral part of its business, and the workers have no opportunity for profit or loss, the factors favor employee status not contractor status. Even though the workers are engaged on a per-job basis and are free to work elsewhere, the IRS has ruled they are employees not contractors in previous cases.

Relationship of the Parties
An independent contractor’s services are typically for separate and distinct projects. However, employees also may be hired on a seasonal or per-project basis. Factors that show how the worker and business perceive their relationship include the permanency of the relationship, the existence of a written contract, the provision of employee benefits, and whether the services provided are considered a key activity of the business.

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The IRS looks at three broad categories in determining whether a worker should be classified as an employee or an independent contractor. If you need help in ensuring that your company correctly classifies employees and independent contractors, please contact us.