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Are You Classifying Your Workers Correctly for State Tax Purposes?

January 16, 2023

Uber had to pay the state of New Jersey $100 million in a settlement of a dispute regarding the misclassification of hundreds of thousands of drivers as independent contractors…make sure you don’t make this mistake! Here’s how to properly classify workers for state tax purposes.

Wondering if your workers are employees or independent contractors? We shed light on a recent incident with Uber and how you can ensure that your employees are classified accurately for tax purposes.

What is the difference between employees and independent contractors?

The main difference between these two worker classifications is that an employee is on a company’s payroll and receives wages and benefits while an independent contractor determines his/her own schedule but does not receive benefits like paid time off or health insurance.

Issue at hand

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.

Misclassifying an employee as an independent contractor:

  1. Saves money on payroll and employment taxes
  2. Possibly reduces the employer’s legal liability for any potential wrongdoings of their misclassified workers.
  3. Saves the employer money on paid leave, health insurance, vacation time and other benefits.

What happened with Uber?

Uber was recently on the hook for $100 million in back taxes after an audit by the state of New Jersey’s Department of Labor and Workforce Development discovered that Uber and a subsidiary had been misclassifying their drivers in the state of New Jersey as independent contractors instead of employees. As a result of the misclassification, Uber did not file or pay New Jersey payroll taxes for unemployment, workforce development and temporary disability.

Employees vs. independent contractors - How do you distinguish between the two?

You must consider your business’ degree of control and the worker’s level of independence to decide whether an individual is an employee or independent contractor. For example, does the worker have to follow another employee’s instructions when completing a project? If that’s the case, the worker should likely be classified as an employee.

For federal purposes, 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 the common law 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?

However, many states impose their own tests to determine if a statutory employer/employee relationship exists. NJ, for example, has a worker classification questionnaire with 17 questions on it. Thus, it is imperative that employers consider the federal guidance as well as the state specific rules to prevent such a costly result.

Are your workers classified correctly? We can help—contact us today.

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