Before hiring individuals to work as independent contractors, businesses should make sure they are on solid ground treating the workers as contractors rather than as employees. Getting worker classification right is important — for several reasons.
PAYROLL TAXES AND INSURANCE
Independent contractors are self-employed and personally responsible for the payment of income and self-employment taxes on their earnings. Unlike with employees, a business isn’t responsible for withholding or paying income or FICA (Social Security and Medicare) taxes on payments made to independent contractors. Similarly, unemployment or workers’ compensation insurance may not be needed (but check applicable state rules before making a determination).
Employees may be entitled to coverage under their employer’s health, retirement, and other benefit plans; independent contractors are frequently excluded from coverage. The Affordable Care Act’s “employer mandate” adds another wrinkle. For 2015, employers with 100 or more full-time (or full-time equivalent) employees in 2014 will be subject to potential penalties unless they provide health insurance that meets the new law’s standards. (The employee threshold drops to 50 for 2016.) Workers who can rightfully be considered independent contractors are excluded in determining employee counts for the employer mandate purpose.
MISTAKES CAN BE COSTLY
Failing to remit payroll taxes or provide benefit plan coverage for “contractors” who later prove to be employees can have serious monetary consequences. Since federal and state agencies have reportedly been doing more worker classification audits, it’s wise to exercise caution. A recent federal appeals court decision demonstrates that companies should not rely on the existence of an independent contractor agreement as their sole support for classifying a worker as an independent contractor.
In most cases, the correct classification of a worker for federal tax purposes is based on the relationship of the worker and the business and the degree of control — both behavioral and financial — the business has over the worker. The more control, the more likely it is that a worker is an employee. Businesses that would like the IRS to determine a worker’s status for purposes of federal employment taxes and income-tax withholding can file Form SS-8.