Each industry has to follow specific hiring procedures and paperwork, particularly for tax and benefit purposes.
When working with independent contractors, you must correctly label them for your business tax purposes. Yet determining who is an independent contractor and who is an employee can be challenging. If you accidentally mislabel a contractor or an employee, this misclassification can cause your employees to miss out on important tax support and government help. It can also trigger an EDD audit of your business and penalties from the IRS.
Thus, incorrectly distinguishing your contractors from your hires could be detrimental to both your recruits and your business. We’ve outlined the differences between the two below, and describe why making this distinction is important to you and your employees.
What’s the Difference Between an Employee and a Contractor?
Though the two terms sound similar, they represent very different things on paper. An employee is someone included on your payroll — a person that you will withhold income tax and payroll taxes (i.e., Social Security tax, Medicare tax, etc.) for the IRS. Every year, you report the wages and tax deductions for your employees to the IRS.
An independent contractor, on the other hand, files their taxes by themselves because independent contractors are not considered your employees. You don’t withhold taxes from a contractor’s wages — they are responsible for paying their self-employment tax. You report your contractor wages on Form 1099-MISC.
The Problems with Misclassification
Sometimes employees are deliberately (and unlawfully) classified as independent contractors so that their employer doesn’t have to worry about paying towards taxes and contributions. Because of this attempt at deception, the government has cracked down and is carefully looking for misclassified employees. The IRS believes that millions of workers aren’t getting the support they deserve because of this mismatch — which is why Form SS-8 is so important.
Misclassified workers miss out on overtime pay, protection from anti-discrimination laws, minimum wage laws, and even workers compensation. They will also have to pay Medicare and Social Security taxes on their own. Because mislabeling staff is causing employees to miss out on so much, it has prompted the government to impose serious penalties on offenders.
If the IRS identifies your employee as a worker and not as a contractor, you’ll be responsible for paying them the money they’ve missed out on along with any associated penalty fees.
What is Form SS-8, and How Does it Help?
If you can’t decide whether your latest hire is an employee or a contractor, you should file Form SS-8. Form SS-8, otherwise known as “Determination of Worker Status,” uses a series of factors to differentiate between contractors and temporary employees. You can file this form immediately, or your worker can file the form themselves if they disagree with your definition.
The form ensures that workers are correctly identified from day one. To complete the form, you will need:
- Information on how the worker got the job
- A description of the work performed by your recruit
- An explanation as to why you believe the person is a contractor or an employee
- Any written agreements or extra information
How Form SS-8 Determines Worker Status
To classify someone with “employee” or “contractor” status, the IRS uses an array of questions segmented into three distinct areas:
- Behavioral Control: First, the government will determine whether you have the right to dictate how the professional does their job. They might ask you questions about daily routines, work assignments, training, or any instructions you provided.
- Financial Control: Independent contractors will pay for their business expenses in regard to tools, facilities, and materials. Contractors are also paid per project or on a straight commission basis. The IRS will ask you questions about worker compensation and reimbursements to determine financial control.
- Relationship Type: Independent contractors don’t have employee benefits like health insurance coverage and paid vacation. They’re also free to offer their services across the market and can work for multiple clients at one time. Contractors also don’t have ongoing, regular relationships with their clients; and if they perform work on multiple projects, it is typically at irregular intervals.
Identifying Employer Status
Both employers and their hires can ask the IRS to determine whether someone is a contractor or an employer by filling out Form SS-8. Once the documentation is complete, the IRS will review the information and determine how they classify the specific worker in question. If the IRS believes that a contractor is an employee, you will be responsible for back-paying wages and taxes if necessary.
To avoid costly mistakes, it’s always better to determine the status of a worker as early as possible. No business wants to be responsible for owing taxes for an entire year. Work with one of our tax lawyers at Milikowsky Tax Law to find out how you can navigate misclassification.