Independent Contractors & Employee Misclassification

Independent contractors and employee misclassification affect US workers, employers, taxpayers, and the whole economy. Under federal and state labor laws, if an employer misclassifies an employee as an independent contractor knowingly or unknowing, there are legal consequences. It is an illegal act and can cost businessowners and corporations considerably in fines, penalties, and employers’ taxes.

Misclassified workers are often taken advantage of when denied access to benefits and protections they are entitled to, including:

  • minimum wages
  • overtime
  • unemployment insurance
  • vacation pay
  • medical leave
  • safe workplace environment

Not only does misclassification costs the employees, but the local, state, and federal governments suffer as well. On a state governmental level, the losses can be enormous in unemployment insurance, funds for workers’ compensation, and tax revenue. It is a constant issue in the construction, delivery, homecare, janitorial, hotels, restaurants, trucking, and other industries.

IRS definitions of an Independent Contractor and Employee?

IRS definition of an independent contractor is a professional working as an accountant, a lawyer, contractor, subcontractor, veterinarian, or doctor. He or she specializes in a trade, business, or profession and works independently providing a service to the public. Independent contractors are subject to paying their own self-employment taxes and federal income taxes to the Internal Revenue Service. Employers must provide their contractors with a 1099-form showing how much money they earned during a specific year.

An employee under the common-law rules is any person who performs services under the control of the employer. Employers have the authority to instruct how to perform and complete their duties and responsibilities. They must withhold federal and social security taxes from each paycheck issued to their employees. During the tax season, workers are provided with a W-2 form detailing the amount of wages earned, taxes withheld, and FICA.

How to Determine Whether a Worker is a Contractor or an Employee Before Hire

IRS provides important factors to consider in determining whether a worker is an independent contractor or an employee. Employers must answer questions divided into three categories, behavioral, financial, and type of relationship. The behavioral category questions if the company has control of how the workers do their jobs.

In the financial category, an employer must ask the following questions:

  • Is the employer in control of the worker’s job?
  • How the worker is paid?
  • Is the worker reimbursed for out-of-pocket expenses?
  • Does the employer supply tools and supplies to the worker for performing his or her duties?

The type of relationship is a factor in determining whether the worker is an employee. The questions asked in this category include:

  • Is there a written contract stipulating the scope of work as an independent contractor?
  • Are there any type of employee’s benefits involved, such as insurance, vacation pay, and/or a pension plan?
  • Will the business relationship between the employer and worker continue indefinitely?
  • Is the performance of work a major position of the business?

The questions listed above are significant in determining whether a worker is an employee or independent contractor. Workers cannot be classified as an employee if they supply and use their own supplies and equipment to perform their jobs. They usually sign a contract specifying their scope of work, pay, and the length of time to complete a job.

Employees on the other hand are hired by employers to hold positions and perform their job duties. Some companies offer a benefit package including health insurance, vacation pay, maternity leave, sick-leave, and/or a 401K. A contract between an employer and an employee is usually for code of conduct, duties/responsibilities, salary, and confidentiality.

Independent contractors and employee misclassification has repercussions resulting in penalties and fines for not paying employment taxes. Workers who should be employees miss out on the benefits they rightly deserve. Governments experience losses in tax revenues, state unemployment insurance, and funds for workers’ compensation.

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