According to the IRS, employee misclassification is a growing problem among small business owners. Employee misclassification occurs in different ways, such as not reporting workers at all or misclassifying workers by the wrong designation.
Today, we’ll look at some tips to avoid employee misclassification. This information can help you keep your SMB in good standing with the IRS.
Types of Employee Misclassification
Employee misclassification is defined as “an act or instance of wrongly assigning someone or something to a group or category.” In the eyes of the IRS, it is illegal to misclassify employees, intentionally or otherwise.
Make no mistake, failing to report workers who are paid “under the table” is illegal. However, many other instances of employee misclassification involve small business owners misclassifying their employees by accident. For example, employees may be incorrectly designated as independent contractors, but this mistake carries some serious tax implications. To avoid becoming a target of the IRS, you should stick with these tips.
Correctly Understand a Business and Employee Relationship
The biggest mistake that most small businesses make is they believe they have the ultimate decision in how they classify a worker. However, according to the IRS, the business/employee relationship comes down to control.
- When the business has the right to control or direct not only what work is getting done, but also how the work is completed, the worker must be classified as an employee.
- When the business is only in control or can direct the final result of the work getting done (and not the means and methods), the employee is classified as an independent contractor.
In an effort to stay in the good graces of the IRS, make sure you follow the rules for classification.
Understand the IRS Definitions for “Control”
Since everything about employee classification comes down to control, you should understand how the IRS defines the term:
- Behavioral Control: When an employer provides exact details and instructions on how they expect work to get completed, they are exercising control over the employee. For example, telling the employee when and where they must work.
- Financial Control: When the employee is expected to fund a significant portion of a job, such as buying tools and equipment from their own pocket, they generally fall under the category of independent contractors. When all or most of the tools and equipment are provided by the company, someone of traditional employee status completes the job.
- Type of Relationship: If the worker receives any type of benefits (health insurance, PTO, sick leave, etc), the worker must be classified as an employee. However, independent contractors do not receive extra benefits from the employer, and the business relationship is usually determined on a project-by-project basis.
Get Assistance from the IRS for Classification
If you are still unsure of how to classify a worker, you can seek the advice of the IRS. The agency produces what is called a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Once the employer fills out the form, the IRS will review the facts and circumstances and officially determine the worker’s status on your behalf. Like most things to do with the IRS, the process is very slow, and it can take at least six months to receive a final decision.
Demand a Written Contract for Independent Contractors
There are stories of older generations relying completely on word-of-mouth commitments when conducting business. Unfortunately, those days are long gone. The bottom line is if you have classified independent contractors on your payroll, you must make sure there is a written contract involved. A contract helps protect your company by clearly defining the working relationship and also backs up your case in the event of an audit.
Tax Advice From the Professionals
There is no set of factors that automatically classify a worker as one status compared to the other, which doesn’t make it easy for employers. The tips above should help you examine the entire business/worker relationship, consider the amount of control over the worker, and document other critical factors.
Instead of waiting on the IRS to reach an employment classification, a tax professional can often help you reach the appropriate conclusion. Levy & Associates has over 20 years of experience and is prepared to assist your small business. Contact us today at www.levytaxhelp.com, or dial 800-TAX-LEVY.