Independent Contractor Classification: Getting It Right

July 21st, 2012

Independent Contractor Classification: Getting It Right


If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. That’s the Internal Revenue Service talking.

The IRS is getting more aggressive at cracking down on businesses that misclassify workers, so it’s more important than ever to stay informed about properly classifying independent contractors. Even if an independent contractor relationship begins at the request of the service provider, the IRS makes the final decision and has the right to change the classification, which could result in employer liability for back payroll taxes, criminal sanctions and invalidation of benefit plans.

On October 13, 2011, legislation titled the “Employee Misclassification Prevention Act” (EMPA) was reintroduced to Congress. If passed, the EMPA would create a new federal offense for both intentional and unintentional contractor misclassifications. It would also create a federal source of new employee rights and empower the Department of Labor to seek expanded monetary damages on behalf of worker. All employers should keep a close eye on this legislation and be very cautious about the classification of independent workers.

The IRS has created a 20-factor test to help employers determine whether a service provider is an employee or an independent contractor. This test indicates whether or not sufficient control is present to establish an employer-employee relationship and should be rigorously applied by employers.

Exercising excessive control over a service provider’s activities is a key factor that could cause an independent contractor to be reclassified. The IRS has identified three primary categories of evidence to determine worker classification, which are described in detail in the Independent Contractor or Employee IRS Training Manual:

Behavioral control. Does the company control or have the right to control what the worker does and how the worker does his or her job?

Financial control. Are the business aspects of the worker’s job controlled by the payer? These include things like how a worker is paid, whether expenses are reimbursed, who provides tools or supplies, etc.
Relationship of the parties. Are there written contracts or employee type benefits, like a pension plan, insurance and vacation pay? Will the relationship continue and is the work performed a key aspect of the business?

Employers should also be aware of the Voluntary Classification Settlement Program (VCSP), a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes. This program provides 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. To participate, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.

One way to avoid this is to partner with Bear Staffing to take those independent contractors and payroll them through us. This payroll service is more comprehensive than using an ADP or Paychex payroll service. Bear actually becomes the employer of record for these employees. We pay wages, payroll taxes and workers comp and handle all separation paperwork. You simply pay an hourly rate. While co-employment may need to be examined under this arrangement, it does solve the Independent Contractor problem for some companies.

Contact us and we’ll be happy to provide you with further information.