Organizations add new workers for a variety of reasons – growth, seasonal spikes, or special projects. Regardless of the circumstances, it’s important to understand whether a new worker is classified as an employee or a contractor.
So what is “worker classification” and how is it determined?
Two common worker relationships are employees and independent contractors. The business relationship between the organization and the worker performing services must be defined before paying for services. The determining factor for worker classification relates to the amount of control over the worker and the services performed.
An organization’s control over a worker falls into three categories:
- Behavioral: Does the organization control or have the right to control what the worker does and how the worker does his or her job? For example, who establishes work hours and procedures?
- Financial: Are the business aspects of the worker’s job controlled by the organization? For example, who provides work space, tools, and supplies?
- Type of Relationship: Is the business relationship permanent or temporary? Is the work performed a key aspect of the business? Are employee-type benefits provided?
Classifying workers as contractors vs. employees can reduce organizations’ employment expenses. Employee compensation is subject to employment taxes, such as the employer portion of social security taxes and unemployment taxes. Independent contractors are responsible for paying all of her or his social security taxes on the net income from self-employment.
What happens if a worker is misclassified?
Organizations that classify an employee as an independent contractor to save on employment taxes may be held liable for that worker’s employment taxes. Past due taxes accrue daily interest and penalties, which can really add up. Accurately classifying workers avoid costly tax issues down the road.