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Are you thinking about hiring some help for your business? Or maybe you already have? It’s important to understand and correctly apply the rules for classifying a worker as an employee or an independent contractor. For federal employment tax purposes, a business must examine the relationship between it and the worker. The IRS Small Business and Self-Employed Tax Center on the IRS website offers helpful resources.
This classification is really important because it determines if you as an employer have to withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. If the worker is identified as an employee, then you are required to withhold employee income tax and pay payroll taxes. On the other hand, you are generally not required to withhold taxes and pay payroll taxes for contractors.
Generally, an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether a worker is a contractor or employee depends on the facts in each situation.
To better determine how to properly classify a worker, consider these three categories – Behavioral Control, Financial Control and Relationship of the Parties.
Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Behavioral control categories are:
Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker’s job? Consider:
Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. This includes:
Classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. Certain employers that can provide a reasonable basis for not treating a worker as an employee may have the opportunity to avoid paying employment taxes.
In addition, the Voluntary Classification Settlement Program (VCSP) offers certain eligible businesses the option to reclassify their workers as employees with partial relief from federal employment taxes.
Workers who believe an employer improperly classified them as independent contractors can use Form 8919 to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.
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