In order to carry out their operations, employers often have both employees and independent contractors. In small businesses, due to their size and workload, the lines may blur between how employers decide who are employees and who are independent contractors. Some businesses may even wrongly classify workers as independent contractors to avoid paying employment taxes.
In recent years, the IRS has been cracking down on small businesses who do not properly classify their workers. They forced businesses to pay back taxes on employment taxes and additional penalties. The IRS set a list of criteria for determining if workers are employees or independent contractors, but ultimately the individual circumstances are considered by the IRS when evaluating a company’s classifications. Nevertheless, here are some general tips to consider regarding your workers to help you properly classify them and avoid clashing with the IRS.
Control over the work done
Generally, if the employer can only control the results of the work that was completed, the worker is considered an independent contractor. However, if the employer provides training, or extensive and detailed direction in how work is to be carried out for a worker and can control the process as the work is done, the worker will likely be an employee. An example of an independent contractor would be a Lyft driver. The company can only control the result (a customer is driven to their destination), but not how the work was done, which is up to the independent contractor (the driver, their vehicle, and how the customer got to the destination).
Financial Control
How a worker is compensated is also considered a determining factor. If the worker has an opportunity for profit or loss, then they are likely an independent contractor. Businesses that do not reimburse a particular worker for expenses incurred may also indicate that worker may be an independent contractor. Going back to the Lyft example, drivers are not reimbursed for expenses related to auto repairs on the vehicles they use, therefore indicating Lyft drivers are treated as independent contractors.
Relationships of Parties
Workers who receive some kind of benefits from the employer are most likely employees. Independent contractors are often only paid on some specific agreement or contract for certain work to be done.
Lets take a look at an example with these considerations:
A small accounting firm in Westminster, CA hires IT help from Orange Coast PC, a sole proprietorship run by Bob Jimenez. He only comes in when needed to help with IT issues on their computers and other electronics, per the terms of their contract.
This is a fairly straightforward and common example of independent contractor-business relationships. The company defined the work terms, so Jimenez only comes in as needed. However, consider the same example, but with these additional details.
Bob Jimenez starts off doing IT work for the CPA firm as needed. The firm needs to develop its own accounting software and requests Jimenez for additional programming work. The software project takes longer than expected, so the firm provides Jimenez a workspace to help him with his work. Jimenez ends up being unable to work with his other clients and focuses most of his time doing work for the accounting firm.
In these additional circumstances, the IRS may look at these details and argue that Jimenez is an employee and not an independent contractor because he spends a significant amount of time working for one firm. In addition, Jimenez does work not in his original agreement and has a workspace provided by the firm. The burden has shifted to the business to prove otherwise through their records and paperwork.
Employee/independent contractor lines get complicated. Our services at MiklosCPA can help with clarifying those lines. We are a California-based CPA firm that supports our clients with their accounting and taxation needs with modern cloud-based accounting systems and the personal touch of individualized, periodic communications. If you would like to learn more about our services, contact us! Or if you enjoy this article, follow us on our social media pages for future updates and new posts!