7 Ways to Avoid Worker Classification Mistakes

7 Ways to Avoid Worker Classification Mistakes

By Jason J. Loven, CPA, CCIFP®

While distinctly different definitions exist for “employee” and “independent contractor,” the line between the two is often blurred. This often happens as part of an organization’s efforts to minimize obligations related to payroll taxes, workers compensation, and benefits. Not surprisingly, this rarely goes over well with the Internal Revenue Service and other agencies like the Department of Labor.

Failing to properly classify your workers can lead to steep fines and penalties—it’s simply not worth the risk. Here are seven things you can do to help prevent an independent contractor from being re-classified as an employee.

  1. Document your company’s policy for defining “employee” and “independent contractor.”

Having a policy and documenting it is wise because it gives everyone in your organization guidelines to follow. At the very least, your policy should detail the qualifying factors you use to determine an employee relationship, which, in the eyes of the IRS, boils down to behavioral and financial control. If you reserve the right to control how a worker does or is paid for the work, this worker is likely an employee. Your policy should define what this looks like in your organization. We recommend following the guidelines outlined on the IRS website to set your policy.

  1. Don’t give your independent contractors business cards.

While this may seem harmless, it can pose a potential worker classification issue. Your independent contractors should not represent themselves as a part of your company. Independent contractors should have their own business cards—not ones that feature your company’s logo or information.

  1. Work with independent contractors who are entities and not just sole proprietors.

Many “solopreneurs” have structured their businesses as entities, while some operate as sole proprietors. Maintaining a staff of sole proprietors, however, could expose you to a potential worker classification issue. When an independent contractor is structured as an entity such as an LLC, it adds support to your position.

  1. Watch your payment method.

The IRS and DOL will also look at how you pay your workers. For this reason, avoid paying independent contractors on a fixed or regular basis, as this is indicative of employee status. Depending on the type of work an independent contractor performs, paying them on a project-by-project basis is often best for avoiding a worker classification hang-up. It’s also important that your independent contractors invoice you for their services.

  1. Make sure your independent contractors work for other people.

An independent contractor who works for only one client could present a red flag for IRS or DOL auditors. The more your independent contractors do business with other organizations, the more obvious it is that they are not employees.

  1. Verify that your independent contractors are paying workers compensation for staff.

If your independent contractor has a payroll, make sure they’re paying workers compensation (and unemployment) as appropriate. (The business owner can opt out.) If they fail to do this, you could be on the hook.

  1. Don’t assume you won’t get caught.

Independent contractors who feel like they’re treated as employees and entitled to certain benefits could report you. And IRS auditors may look at your wages versus independent contractors during an audit. The may even tip off the DOL and others. At the end of the day, you could face penalties for unpaid payroll taxes and late fees, unpaid workers compensation insurance, and more.

Thankfully, steering clear of these mistakes is fairly easy. At JAK, we can offer guidance on your circumstances and situation. If you are unsure about your independent contractor roster, don’t hesitate to give me a call.

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