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Are They an Employee or a Contractor? The Answer Matters!

By Outsourced Technology Manager Hunter Westfaul

Whether you are an employer or an individual, the subject of being an “employee” versus “contractor” may have a significant impact on your financial liability.  Although one may have a rough idea of the difference, there are a few exceptions out there that can be confusing, as well as consequences one may not have considered.

First, what is an “employee”?  Although receiving a W-2 usually indicates one is an employee, the employer may not be classifying them correctly.  The IRS has several criteria they look at when making this determination, and it’s helpful to understand these items to ensure that one is making the correct classification.

  • What degree of control does the employer have over the worker? Does the employer set the specific time, location, and manner, in which the worker must perform their job?
  • Does the worker face the possibility of making a profit or loss on the job?
  • Does the employer provide the facilities, equipment, and other material necessary to perform the job, or does the worker cover these expenses?
  • What is the nature and length of the relationship between the employer and worker? Is it on a job by job basis, or is it a long-term arrangement?  Also, is the relationship mostly exclusive, or does the worker perform work for many other employers?

Employees tend to be under more control by an employer than a contractor.  They may have regular hours in which they are expected to perform their work, may be required to work at a specific location, and the way they perform their work may be dictated by their employer.  Employees typically have their job costs covered by their employer, which means they usually are not facing a potential loss in performing the work.  They usually have their facilities and equipment provided by their employer, and have longer-term engagement within the position.

Determining the correct classification of a worker is important for both the employer and the individual performing the job.  If the worker is an employee, the employer is required to withhold income, social security, and Medicare taxes from the worker’s pay, and must pay social security, Medicare, and unemployment taxes for the worker as well.  If an employer tries to “pull a fast one” and classify an employee as a contractor, hoping to avoid withholding and remitting requirements, they will be subject to fines and penalties from the IRS (not to mention state and local agencies).

If the worker is a contractor, the employer is simply required to issue them a 1099-MISC – no withholding or remitting of taxes is usually required.  However, if the contractor is new or unfamiliar with the requirements, they may not realize that they are responsible for remitting their own income and self-employment taxes; many new contractors are surprised on April 15th when they’re told they owe tens of thousands of dollars in taxes for the year!

Ensuring that a worker is correctly classified as an employee or contractor is important for both parties.  With the potential taxes, fines, and penalties at stake, it’s just good business to make sure you’re on the right side of the law.  For more information, as well as a deeper dive into these designations, review this IRS fact sheet.

Furthermore, review our employee vs. contractor infograph here for a quick run down on the differences between the two. For more information or if you have questions regarding properly classifying your employees and contractors contact me at hwestfaul@sstcpa.com.