Federal tax law draws defining lines between employees and independent contractors, but these boundaries can blur at times, and misinterpreting them can have negative implications for employers. Three tests are typically used to define a worker’s status for tax purposes: Behavior, financial and relationship tests.
In terms of behavior, independent contractors typically make their own schedules, work on a deadline, provide their own supplies and have more discretion over how a task is completed. Independent contractors are also given more financial control, as they do not work for periodic wages and can take on multiple clients. Employees, in contrast, are typically banned from soliciting work from other clients and are subject to the wage structure their company imposes.
Lastly, the relationship between employers and contractors is more detached than those of workers, in that the former does not receive benefits and works on specific projects typically for a predetermined amount of time. Further, they must generally carry out the task to satisfy the terms of their contract before they quit a job, should they decide to do so.
While certain work scenarios can make determining a worker’s status difficult, IRS implications can be heavy for employers who misclassify employees
and contractors who claim certain job-related deductions. Due to the tax gap between taxes owed and taxes that are actually paid, business owners are facing more scrutiny from the IRS. Employers may be held accountable for unpaid withholding taxes and benefits, as well as a 100 percent penalty for failure to collect and account for employment taxes.
Independent contractors are solely responsible for paying their share of Social Security and Medicare payroll taxes, as well as that of the employer’s. Further, misclassified independent contractors who claim home office deductions due to telecommuting privileges can also trigger an audit and face tax penalties.