The IRS estimates that millions of workers are misclassified as independent contractors, costing the federal government huge sums of tax revenue due to underreported income and related unpaid employment taxes.

If the IRS reclassifies a worker as an employee, the employer:

1. Becomes liable for:
   1. Employment taxes that should have been withheld from workers pay, such as FICA, federal and state income taxes.
   2. The employer’s share of FICA taxes,
   3. State and federal employment taxes,
   4. Penalties and interest for failure to (a) pay these taxes, and (b) file payroll tax returns and
   5. May have a retirement plan retroactively disqualified, which could cause all vested accrued benefits to become taxable for employees in the plan.

In the past the Internal Revenue Service used a “Twenty Factor Test” to determine whether or not an individual could be categorized as an independent contractor. The factors have since been consolidated into eleven main tests and organized into three primary groups: behavioral control, financial control and the relationship between the parties.

Behavioral Control

This is based on the facts and circumstances that show whether the business has a right to direct and control the performance of the individual in question.  The behavioral control test is separated into two items:

1. Instructions the business gives the worker.
2. Training the business gives the worker.

Financial Control

Showing that a business has a right to control the business aspects of the individual’s job include:

1. The extent to which the worker has unreimbursed business expenses. 
2. The extent of the worker’s investment.
3. The extent to which the worker makes services available to the relevant market.
4. How the business pays the worker.
5. The extent to which the worker can realize a profit or loss.

Type of Relationship

Factors showing the type of relationship between the parties include:

1. Written contracts describing the relationship the parties intended to create.
2. Whether the business provides the worker with employee-type benefits such as insurance, a pension plan, vacation pay, or sick pay.
3. The permanency of the relationship.
4. The extent to which services performed by the worker are a key aspect of the regular business of the company.

If you have questions about employees vs. independent contractors please call Greg Lewis at 714.569.1000.