Employee or Contractor? | RKL LLP
Posted on: July 14th, 2014

Employee or Contractor? Not Knowing the Difference Could Cost Your Business

Business team standing in cubicle smiling

The lack of a definitive test for classifying employees vs. contractors presents unique challenges to employers, who are nonetheless responsible for compliance.

In today’s business climate, employers are increasingly using outside workers to reduce expenses, including payroll tax costs. The classification of a worker as an employee or as an independent contractor can mean a substantial difference in the amount of employment taxes the business pays.

With the new health care reform law imposing coverage requirements on an employer with more than 50 full-time employees, it may be even more tempting for many employers to hire independent contractors instead. It is one thing to legitimately employ an independent contractor, however, an employer who misclassifies his employees either inadvertently or deliberately to minimize its employment tax or health care coverage responsibilities may become subject to interest, penalties and even tax liens.

Employee or Contractor: Telling the Not-So-Simple Difference

Despite the importance of the decision, classifying a worker as either an independent contractor or an employee is not straightforward. The lack of a definitive test for classifying workers, coupled with confusion and uncertainty about the application of existing rules, contributes significantly to the worker classification problem. The determination depends on a number of factors and can be quite complex.

The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done).  However, it is not necessary that the business actually direct and control the worker, but rather that the business has the right to do so. What matters is that an employer has the legal right to control the details of how, when and where the services are performed.

Below are some guidelines to be used when making your determination: Keep in mind that the IRS will make its decision based on the whole picture, not just a single factor.

Workers are more likely to be classified as independent contractors if they:

  • Make a significant investment in business property, such as tools
  • Pay their own business expenses
  • Receive a flat fee that is not based on an hourly or similar rate
  • Are not prohibited from doing work for other companies
  • Can pay subcontractors to get the job done
  • Are not performing services as an integral part of your regular business

Workers are more likely to be classified as employees if they:

  • Are given specific instructions and on-going training in how to get the work done
  • Cannot work for others
  • Have expenses paid by your company
  • Are paid with a salary or hourly wage
  • Do not make a significant investment in their trade or business
  • Are an integral part of your regular business
  • Receive direct reimbursement for all, or almost all, expenses

Fortunately, for employers who may have misclassified their employees as contractors, the IRS is currently offering a Voluntary Classification Settlement Program. The program provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from past federal employment taxes. To participate, the employers must meet certain eligibility and application requirements. For help, contact your RKL service provider.

Reading, Michael_croppedContributed by Michael Reading, CPA, supervisor in RKL’s Small Business Services Group. Michael is an experienced accounting and tax professional with more than ten years experience helping companies meet compliance obligations, minimize taxes, meet their financial reporting needs and achieve success. He specializes in working with small businesses in industries including construction, manufacturing/distribution, retail and others.


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