The global economy is shifting to a greater reliance on self-employed individuals and “gig” (remote or self-scheduled) workers. As a result, determination of whether someone is an employee or an independent contractor can be difficult.
Companies do not withhold income, Social Security or Medicare taxes on independent contractors’ compensation.
If it is determined that your company misclassified employees as independent contractors in order to evade taxes, federal and state agencies are poised to impose stiff penalties for employee misclassification and for late filing submissions.
Your CPA can help you analyze the proper classification
There are three primary factors to consider when deciding whether to classify someone as an employee or as an independent contractor: behavioral control, financial control and the relationship of the parties.
Behavioral control examines whether the employer directs or controls how work is completed by the worker. Considerations include whether the individual is required to work set hours on a full-time schedule.
Are they required to work at the organization’s place of business? Are they required to use certain tools or purchase their supplies from a specific vendor? Do they undergo the same on-boarding process as employees? Did the company train the individual on how to perform the job? Is that training ongoing? Is there an ongoing measurement of the individual’s performance? Will the company hire and pay for an assistant?
An affirmative answer to any of these questions points to an employer and employee relationship.
When considering whether a company has financial control over an individual, look at the compensation arrangement. An individual contractor might negotiate a fee for the job while an employee would be guaranteed a salary or hourly wage paid on a regular schedule. A company is more likely to compensate an employee for travel expenses, whereas those expenses for an independent contractor could remain unreimbursed.
If the company made a significant investment in tools, equipment, and/or supplies, the individual is more likely to be classified as an employee. An independent contractor is usually available to perform services for the general public and has an opportunity for a profit or loss.
Relationship of the parties
It is important to define the relationship of the parties. This can be accomplished through an independent contractor agreement.
Independent contractors are not usually granted the same types of benefits to which employees are entitled and should not be provided with an employee handbook. An employee would be assumed to be employed indefinitely while there is usually a beginning and an ending to a contract with an independent contractor. An independent contractor is not generally responsible for an integral element of the operations of the business.
Your CPA can help with the reporting rules
An important first step in the process is to obtain a completed Form W-9 from all independent contractors before you make any payments. The 1099-MISC filing requirements depend upon the federal tax classification indicated in line 3 of the W-9.
Generally, a business should provide IRS Form 1099-MISC to independent contractors and certain other parties. For example, if you pay more than $600 in rent to a property owner for office space, you should report those payments. If you are paying a real estate agent or property manager, you do not need to report the payments. The agent or property manager is responsible for issuing a statement to the owner.
If your business pays an independent contractor via credit card or Paypal, you are not responsible for issuing a 1099-MISC. The third party payment processor will issue a 1099-K to the contractor.
If you are reporting nonemployee compensation (NEC) regardless of whether you are filing via paper or electronically, you are required to file Form 1099-MISC by Jan. 31 with both the IRS and recipients. The deadlines are rapidly approaching, so be sure to consult with your accounting professional.
Ryan Skuce joined Earney & Company, L.L.P. in 2003, and became a partner in November 2013. He works extensively with physicians, medical practices, and large medical groups. Ryan has experience in accounting and tax services including financial reporting and analysis, technical support, cash flow planning, physician compensation strategies, and medical practice strategic planning. He also has experience in the areas of accounting and tax for a variety of for profit and nonprofit clients. Ryan is currently a member of the American Institute of Certified Public Accountants (AICPA) and the North Carolina Association of Certified Public Accountants (NCACPA). Ryan works with his clients on evaluating operational and technical issues. He provides back-office accounting support, and recommends and assists in the implementation of ideas to cut overhead costs and streamline operations. With an in-depth knowledge of existing and proposed tax laws, Ryan often advises companies on tax deferment or savings through proactive structuring of transactions. He also assists his clients with Internal Revenue Service audits. He received his Masters of Science in Accountancy from UNC-Wilmington and resides in Wilmington, where he enjoys playing hockey with a local team.