Correct Worker Classification Essential for Avoiding Penalties
Most workers fall into two categories:
- Independent contractors
- Common-law employees
The main factor in determining a worker’s classification is how much control the business has over the worker. The more control the business has the more likely it is that the worker is an employee rather than an independent contractor.
According to the IRS, a business must base its determination as to whether a worker is an employee or an independent contractor on all the facts and circumstances of its relationship with the worker. Businesses can use Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to have the IRS make the determination.
It is critical that the business correctly determine whether the individuals providing services are employees or independent contractors. An employer must withhold income taxes, withhold and pay Social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. In addition, other tax issues, including the provision on certain employee benefits, depend upon the proper classification of workers.
A business generally does not have to withhold or pay any federal taxes on payments to independent contractors. However, independent contractors are subject to self-employment tax and should plan accordingly.
If a business incorrectly classifies a worker, the business could be subject to penalties.
There may be relief for employers who want to correct any errors they may have made by classifying an employee as an independent contractor.
Headliner Volume 152: IRS Offers Tips on How to Correct Misclassification of Employees,  contains additional information about correcting worker classification.