contractorsAs businesses in America have increasingly hired independent contractors as a way to manage or cut costs, the IRS has ramped up its crackdown on employee classification violations. And we’ve heard many States are cracking down as well. In California, for example, employers are at risk of being charged with Worker’s Compensation Fraud for misclassifying employees as independent contractors.

Small business who hiring independent contractors as virtual employees in order to avoid paying Social Security and Medicare taxes risk receiving an IRS violation notice.

If your business uses an independent contractor, you need to be sure you have classified him or her appropriately. The IRS uses 20 factors in determining whether a person is an independent contractor. These factors fall into three main categories:

Financial control. A worker is generally classified as an employee if he or she is guaranteed a regular wage amount over time and is not allowed to offer their services to other businesses.

Behavioral control. A worker is generally classified as an employee if you dictate when and where work is to be performed, provide training, specify the tools or equipment to use or employ other detailed instructions that exercise control over the worker.

Relationship between the parties. A worker is generally classified as an employee if they are offered work over an indefinite period of time, do not have a written contract, are provided with benefits like insurance or paid vacation and if the work provided is a key activity of the business.

Businesses that misclassify employees as independent contractors are subject to a fine that includes a percentage of the income tax that should have been withheld and the business’ share of the FICA and unemployment taxes, as well as interest and penalties. If the IRS deems the misclassification to be “willful,” harsher penalties apply.

Before you hire independent contractors, consult with an attorney to be sure you comply with IRS (and State) regulations. We can help you draft a written contract that details the duties of the contractor and keeps you on the right side of the law.

If you’re a small or mid-size business owner, call us today to schedule your comprehensive LIFT (legal, insurance, financial and tax) Foundation Audit. Normally, this session is $1,250, but if you mention this article and we still have room on our calendar this month, we will waive that fee.