One of the most common kinds of employment fraud is a company treating somebody as an independent contractor when they are, in fact, an employee. Sometimes this is malicious, an attempt to avoid paying as much in benefits and workers' compensation. However, some companies also do this by accident because they are not familiar with the rules. The following things make it much more likely that the IRS will rule somebody an employee:
1. You control when and how they work. Excessive mandatory meetings, required hours, expecting the contractor to be on site when they could easily work remotely can all cause a problem. Also, contractors should not be obliged to sign non compete clauses that make it hard or impossible for them to work for other clients.
2. You provide them with vital tools and supplies. Contractors should provide their own equipment, supplies, etc. You should only provide them materials directly related to the specific job being done.
3. The work they do is integral or key to the company, such that you could not continue business without them.
4. You provide them with any benefits such as health insurance. If you do so, the contractor must pay income tax on the value.
5. You refer to them as an employee in contracts or other official documents. This simple mistake can get you into a lot of trouble. Always use language such as "contractor" or "freelancer."
So, what are the consequences of misclassification? They can be pretty severe, so if you are in doubt consider taking the person on as an employee. Here are some things to worry about:
1. You may become liable to pay the tax that would have been withheld if the contractor was an employer if they try to evade taxes or refuse to pay.
2. Contractors are covered by their own liability insurance. However, if somebody is misclassified and is then injured on the job, you may be liable for their injuries and pay penalties for not carrying workers' comp for that individual.
3. You might end up having to pay unemployment benefits after they leave the job.
4. You could be sued for not paying minimum wage, not paying overtime, etc.
In other words, you shouldn't use independent contractors except for the kind of thing they are best for, such as specific projects or expertise, or covering for maternity or other extended leave. To find out more about the tax consequences of misclassifying workers, contact Foster Financial CPA today.