October marked another month of steady job and wage growth. But what about those who are not paid by the hour? The workers who are independent of a boss/employee relationship, and instead are contracted with to a specific job. Sometimes these people, independent contractors, are not factored into job or wage growth, but the number of them is increasing. Employers are realizing the benefits of decreased liabilities, and independent contractors are benefiting from working on their own terms. However, what many employers/companies don’t realize is that whether or not a worker can be treated as an employee or independent contractor depends on specific guidelines set out by the Internal Revenue Service (IRS) and classifying a worker incorrectly could lead to heavy costs.
The line between what makes someone an independent contractor or employee might be a lot thinner than you think, but the differences between the two can be great. For instance, most independent contractors are not entitled to most statutorily imposed employer obligations including taxes, minimum wage, employment benefits, and worker’s compensation. Unfortunately, sometimes employers take advantage of workers by classifying them as independent contractors to avoid paying for these employee benefits, but there are laws in place to protect workers when they should be recognized as an employee. So, to help guide employers, employees, and independent contractors to the right label, this month we will be breaking down the differences between the two.
No one set of factors determines if someone is an employee or an independent contractor, rather the difference between the two depends on the specific facts of the relationship. The IRS has set forth categories of factors that employers/companies can look at to determine if someone can be classified as an independent contractor. The three categories are:
- Behavioral Factors: Does the company control or have the right to control what the worker does and how the worker does his or her job?An independent contractor usually is thought to have control of how and when they do their work, if the payer controls how and when tasks are to be completed, then it is more likely that person is an employee.
- Financial Factors: Who bares the financial obligations of the worker’s job? The more that a “contractor” must spend on providing their own equipment, the more likely that person is an independent contractor. If the “contractor” is paid by the job/task then he/she is more likely an independent contractor, if paid by the hour for an indefinite period of time, the person is more likely an employee. If the “contractor” is exposed to potential loss and liability for their work, the person is more likely to be an independent contractor.
- Type of Relationship: Are there written contracts or any employee type benefits? Will the relationship continue and is the work performed a key aspect of the business? If an “contractor” receives a pension plan, insurance, vacation pay, or other typical employee benefits, the person is more likely an employee. Contracts will typically be honored if someone agreed to be an independent contractor in writing, unless other factors weigh more heavily against that agreement. The more permanent the relationship, the more likely the person is an employee. The more the contracted work is like the typical work of the payer, the less likely the person is to be an independent contractor.
There is no rule that establishes that any of these factors automatically makes someone an employee or an independent contractor. Each factor can be weighed differently depending on the facts. The type of relationship is wholly dependent on the circumstances of the situation, and depending on where you are located, the laws may be different in your state.
Pennsylvania Unemployment Compensation Law considers two factors to be of the most important when determining the relationship, and will not find a contractor position where these two factors do not exist. First the “contractor” must be free from control or direction over the performance of the services involved. Second, the “contractor” must be engaged in an independently established trade, occupation, or business. This often means that the contractor is free to take on other work and has other clients, work, etc.
Another thing to note in Pennsylvania, determining if a person involved in construction is an independent contractor is a little more straightforward thanks to Act 72, or the Construction Workplace Misclassification Act. This Act establishes specific criteria that must be met for a construction worker to be classified as an independent contractor. If the specific factors are not met by the “contractor”, then the payer is in violation of the Act.
One quick caution, penalties for misclassification can be detrimental to a business. If a payer makes the wrong determination about an independent contractor that should have been an employee, the payer could be obligated to pay Social Security and Medicare taxes for the employee. That is why it is important to document how and why a person is deemed an independent contractor. Workers who believe they are improperly classified as independent contractors can use Form 8919, to report the employer, and determine the uncollected taxes.
If you are concerned a person is not rightfully considered an independent contractor or an employee, you can file a Form SS-8 to receive the answer from the IRS. While it can take up to six months to receive an answer, the IRS will make an official determination based on the circumstances.
In conclusion, determining someone’s work status can be difficult, but employers can look to these factors as good guidance. If the factors still leave the status murky, you should talk to your attorney or accountant to discuss your specific situation. We’re always happy to help and/or help you find an accountant as well.
This blog post is for informational purposes only. It does not create an attorney/client relationship and is not meant to be relied upon for legal advice. Contact Trellis Legal if you wish to discuss a specific issue.