“Is my worker a contractor or an employee?”
It’s a common question but how you decide to classify your workers is important, particularly for the Department of Labor and the IRS. The distinction between an employee or contractor has a big impact on your workers, including how they’re paid, their eligibility for benefits, and how they pay taxes.
In some cases, employers attempt to treat employees as independent contractors to avoid important responsibilities like paying for benefits and taxes. While other times, employers make a genuine mistake when interpreting the rather daunting guidelines that come with classifying workers.
To avoid issues with the DOL or IRS you have to accurately classify your workers. To help you do that, here are a few important considerations for classifying workers.
Consider the Company-Worker Relationship
If you want to properly classify your workers, you have to consider every part of the relationship between your company and the worker.
Avoid the mistake of basing your decision on any single factor. In fact, the US Supreme Court indicates that there are multiple factors to consider and the sum of activities and/or the situation that determine the classification. To clarify the US Supreme Court has identified these factors as significant to classifying workers:
The extent to which services rendered are an integral part of the company’s core business
The permanency of the relationship
The amount of the worker’s investment in facilities and equipment
The nature and degree of control by the company
The worker’s opportunity for profit and loss
The amount of initiative, judgment, or foresight in open market competition that’s required for success
The degree of independent business organization and operation
Do Not Base Worker Classification Solely On Written Contracts
You may think that having a signed contract that defines a worker’s classification means you are free from other considerations, however, this isn’t the case.
As far as the IRS is concerned, it is the relationship between the employer and the worker that determines the classification, not the contract. This is true even if the contract is written by a legal professional, signed, and notarized.
Defining a Significant Investment
The IRS defines a significant investment in job training and equipment by the worker as representative of an independent contractor. While both employees and contractors may invest in the tools and materials needed to complete jobs to some degree, the classification is determined by the size of the investment and whether or not they are reimbursed by the employer.
This can create some confusion as there is no specific value that defines a “significant investment.”
How the Worker is Paid
In many cases, employees are paid a consistent wage per hour, even in the event that they are earning commissions or other incentives. Contractors on the other hand are often paid a fixed-price but can also be paid hourly. This can cause confusion for employers because there is no standard for how a worker is paid.
Therefore, you cannot determine the classification of a worker based on how they are paid.
Benefits as a Determining Factor
Employees are often provided benefits such as paid time off, retirement savings plans, and health insurance by their employers. That said, this isn’t always the case. If an employer doesn’t provide benefits to a worker, it doesn’t mean that worker isn’t an employee.
Employers aren’t obligated to provide benefits to their employees, unless required by laws such as the Affordable Care Act mandating that employers provide health insurance in certain circumstances. Contractors, on the other hand, are never offered benefits.
Some employers mistakenly think they have the choice of offering benefits and treating the worker as an employee, or not offering benefits and treating the worker as a contractor.
Consider Industry Standards
It’s possible that several employers within a particular industry will tend to classify workers one way or another – despite the reality of the working relationship. This may be because it’s advantageous for the employer or maybe it’s what the worker prefers.
In other words, it may seem like “the standard” within that industry, but that doesn’t mean it’s correct. Just because other employers are doing it a certain way, it doesn’t mean you won’t face consequences if audited by the Department of Labor.
Determining the classification of a worker can be confusing, however, if you remember these points you’ll be better suited to make that call:
No single factor is enough for a concrete classification.
Consider how business is conducted between your company, not what is stated in any written contract.
A worker’s significant and unreimbursed investment in their tools and training is a good indicator.
Pay structure alone doesn’t determine classification if the other aspects of the working relationship remain unchanged.
Benefits are offered to employees, however, that isn’t a reliable indicator of whether worker classification is accurate.
When in doubt, engage an employment law professional to help you determine how to claffy your workers.