In general, business growth is accompanied by an increased number of employees, which in turn is accompanied by increasing tax challenges and employee benefits. Many business owners may be tempted to minimize the impact of these challenges by classifying workers as independent contractors rather than employees. However, it is critical that business owners correctly determine that the individuals providing the services are employees or independent contractors.

Business owners have several legal obligations arising out of wages, including the responsibility to withhold income taxes, withhold and pay Social Security and Medicare taxes, pay unemployment taxes on wages paid to employees along with various payroll filing and reporting requirements. In contrast, the legal obligation of independent contractors is very limited and includes the annual preparation and filing of Form 1099.

A key factor in determining whether a person providing services is an employee or an independent contractor is the question of control; consequently, all information that provides evidence of the degree of control and independence should be considered. According to the Internal Revenue Service (“IRS”), the facts that provide evidence of the degree of control and independence fall into three categories: (1) behavioral: the company controls or has the right to control what the worker does and how the worker does worker does his job; (2) Financial – The business aspects of the worker’s job, including how the worker is paid, whether expenses and ownership of supplies, tools, and equipment are reimbursed, are controlled by payment, and (3) the type of relationship: when the type of work performed by the worker represents a key aspect of the payers’ business; and the worker renders services exclusively for pay; the worker is most likely an employee.

It is critical that business owners consider the entire relationship, consider the degree or extent of the right to direct and control the relationship. In addition, business owners must document the factors used to arrive at the determination.

Misclassifying employees as independent contractors can result in significant costs, as the employer may be liable for payroll taxes on those employees. However, if there is a reasonable basis for an inaccurate classification, the employer may obtain partial relief of associated financial responsibility, subject to compliance with certain corrective actions from the IRS, such as participation in the Voluntary Classification Agreement Program, (” VCSP “). Under the VCSP, taxpayers have the opportunity to properly reclassify their workers for future tax periods, with partial relief from federal employment tax obligations.