For proper tax withholding, tax reporting, and payroll processing, business owners need to correctly determine whether individuals’ providing business services should be classified as employees or independent contractors.

Employee Designation Characteristics

An individual is considered to be an employee based on the following criteria:

1. The individual performs services for the business
2. The business can control what work will be completed by the individual
3. The business can determine how the work the individual performs will be completed
4. The business has the right to control the details of how the worker’s services are completed

Independent Contractor Designation Characteristics

Independent contractors are typically individuals in an independent trade, business, or profession in which they offer services to the public. Examples of independent contractors include doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers. However, these individuals may be performing services as an employee if they work for one company, report to the business owner, and are provided with the tools needed to perform the work.

Another factor in determining the correct classification is whether the individual receives a regular paycheck regardless of the work performed or are paid by their clients based on a contractual understanding.

Whether a worker is an independent contractor or an employee depends on the relationship between the worker and the business. Generally, there are three categories to consider:

1. Behavioral Control – does the company control or have the right to control what the worker does and how the worker does the job?
2. Financial Control – does the business direct or control the financial and business aspects of the worker’s job? Are the business aspects of the worker’s job controlled by the payer? This would be factors such as how the worker is paid, are expenses reimbursed, who provides tools/supplies, etc.
3. Relationship of the Parties – are there written contracts or employee type benefits provided by the company to the individual>? Examples include a pension plan, insurance, and paid time off. Additionally, will the relationship continue and is the work performed a key aspect of the business?

Misclassifying workers as independent contractors affects employees because the employer’s share of taxes is not paid and the employee’s share is not withheld. If a business misclassified an employee without a reasonable basis, the business could be liable for employment taxes for that worker. Typically, an employer must withhold and pay income taxes, Social Security and Medicare taxes (jointly considered FICA taxes), as well as both federal and state unemployment taxes. Workers who believe they have been improperly classified as independent contractors can use IRS Form 8919 – Uncollected Social Security and Medicare Tax on Wages – to calculate and report their share of uncollected Social Security and Medicare taxes due on their compensation.

Voluntary Classification and Settlement Program

The Voluntary Classification Settlement Program (VCSP) provides taxpayers with an opportunity to reclassify workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. Taxpayers must meet certain eligibility requirements, apply by filing Form 8952 – Application for Voluntary Classification Settlement Program – and enter into a closing agreement with the IRS.

Self-Employed Characteristics

Generally, an individual is considered self­-employed if any of the following apply:

1. The individual carries on a trade or business as a sole proprietor or an independent contractor.
2. The individual is a member of a partnership that carries on a trade or business.
3. The individual is in business for themself, including a part-time business.

Self-employed individuals generally are required to file an annual tax return and pay estimated tax quarterly. They generally must pay self-employment tax (Social Security and Medicare tax) as well as income tax. Self-employed taxpayers may be able to claim the home office deduction if they use part of a home for business.

Gig Economy Characteristics

The gig economy, also called sharing economy or access economy, includes individuals who earn income providing on­-demand work, services, or goods. Gig economy income must be reported on a tax return, even if the income is from part-time, temporary, or side work; not reported on Form 1099-K, 1099-NEC, W-2 or other income statement; or paid in any form.

Understanding how to properly classify individuals as independent contractors or employees is critical for tax withholding and reporting. To learn more about worker classification and tax withholding and reporting requirements, contact U.S. Taxes, Inc. at inquiries@ustaxesinc.net or 1-609-588-8181.