Employee or Contractor?

The Decision Could be Costly

By Robert J. Dunn

When many small businesses are looking to expand or add new staff, they believe adding contractors is the best way to go.  The rationale for this decision is based on the assumption that contractors cost less than employees.  The reality of this decision can be quite the opposite.  

The Internal Revenue Service, the government agency responsible for monitoring this employment area, is conducting random audits over the next 3 years.  The audit will consist of an extensive review of employment tax returns and related issues.  The status of any independent contractor working for the company will be a major part of this audit.  The audit will also look at executive/owner Compensation, fringe benefits, and failure to pay issues. 

The consequences for misclassifying employees are quite costly for employers.  The employer found to have misclassified will be responsible for a percentage of the withholding taxes, employer’s share of FICA taxes, a portion of the employee’s FICA taxes, and interest and penalties.  Misclassified employees may also be eligible for health benefits, pension, workers compensation and unemployment compensation retroactive to their date of employment as an independent contractor. 

If a business is using independent contractors, it should conduct its own audit to confirm that the contractors are accurately classified.  The IRS has used a Twenty Factor test in the past to help determine the status of an independent contractor. Currently, the IRS looks at Three Relevant Factors to help determine contractor status.  These factors are: Behavioral Controls, Financial Controls and Relationship of Parties.  The Behavioral Controls show whether there is a right to direct or control how the worker does the work.  The Financial Controls show whether there is a right to direct or control the business part of the work.  The Relationship of Other Parties illustrates how the workers perceive their relationship. 

This issue can be extremely costly for employers if they misclassify their employees or contractors.  This article provides information only, and if you have any questions you should contact your attorney or Human Resources Consultant.  

 Robert J. Dunn is President of Robert J. Dunn Associates and chair of the Chamber’s Human Resources Committee. 

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