Is Your Worker an Employee or Independent Contractor?July 22, 2016
Would the IRS be content with your employee classifications? Read on to find out if you are complying with IRS regulations and classifying workers correctly.
Have you appropriately classified all your workers? The IRS continues to crack down on organizations that incorrectly classify workers as independent contractors rather than employees. By incorrectly classifying employees as independent contractors, Organizations are able to reduce labor costs and avoid paying certain state and federal taxes.
How can I tell who is who?
You must consider your nonprofit’s degree of control and the worker’s level of independence to decide whether he/she is an employee or independent contractor. There is a set of questions set forth by the IRS to help in the determination process, known as the “common law rule,” or the “20 factor test”.
Questions in this test fall under the following three categories:
- Behavioral- Does your organization have the right to control the worker and how that person performs his or her duties?
- Financial- Is there a written contract between the worker and your organization? Does the worker receive employee benefits? Are the business aspects of the worker’s job regulated by the payer? (How the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship- Are there written contracts or employee type benefits (i.e. insurance, pension plan, vacation pay, etc.)? Will the relationship continue and is the work performed a crucial piece of the business?
Example -- Does the worker have to follow another employee’s instructions when completing a project? If that’s the case, the worker is likely classified as an employee.
Other helpful indicators:
Generally, employees are:
- Trained for a specific purpose/job.
- Paid by the hour, week or month
Typically, independent contractors are:
- Already trained on how to do something
- Required to pay their own assistants
- Able to set their own daily schedule and hours
- Working at more than one company at a time
What happens if the IRS finds that I’ve misclassified an employee?
You might be held personally liable for the worker’s applicable employment taxes if you’ve improperly classified him/her as an independent contractor when in reality he/she is an employee.
Employees- Employers, you must complete Form W-2 every year for workers classified as employees, as well as withhold income tax and the employee’s portion of Social Security and Medicare taxes from his/her pay. In addition to this, you (the employer) must also pay the employer portion of Social Security, Medicare and unemployment taxes on the employee’s wages.
Independent Contractors- For workers classified as independent contractors, the Organization must complete Form 1099-MISC, which is used to report the amount you’ve paid to the person during that calendar year. Independent contractors have to pay both the employer and employee share of social security and medicare taxes, and might be subject to quarterly estimates for both federal and state income taxes, as the employer is not required to withhold incomes taxes. The IRS has found that it’s more difficult to collect from independent contractors even though they should generally receive the same amount of total income and employment taxes regardless of whether someone is an employee or an independent contractor. It’s no secret, then, that the IRS is more inclined to favor the “employee” status.
“Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding”
Keep in mind that your workers have the right (as do you, the employer) to go to the IRS and ask for a determination on whether individuals are employees or independent contractors. A worker can file Form SS-8 and bring his/her relationship with your nonprofit to the attention of the IRS—and you do not want to provide the IRS with a reason to audit your organization.
Consult your tax advisor before filing such form.
Make sure your organization is adhering to these rules—the IRS has lost millions in unpaid taxes and is looking to put an end to this loss.
Contact any member of our Not-for-Profit Services Team for more guidance on this issue.