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The importance of classifying workers correctly

On Behalf of | Dec 1, 2021 | Tax Controversies |

Business owners have a variety of responsibilities. Managing workers correctly is one of them.

When it comes to classifying workers, the two options are typically an employee or independent contractor. Employers must classify correctly, or there will be financial and tax implications.

Employee vs independent contractor

According to the Internal Revenue Service, the main consideration that comes into play when classifying a worker is the amount of control the employer has. When it comes to an independent contractor, the employer only has control over the result of the work, not how or when the individual performs the work. An IC has much more freedom but is usually responsible to supply all necessary materials. An employer typically pays a contractor for an amount specified by the contract.

For an employee, an employer can outline the worker’s schedule as well as how to perform the job. An employee gets a salary or an hourly wage as well as certain employer-sponsored benefits such as vacation pay, sick days, health insurance and retirement.

A company does not withhold any taxes for an IC. Alternatively, an employer must withhold Social Security, income and Medicare taxes for an employee.

Penalties for misclassification

Whether an employer misclassifies an employee as an IC due to ignorance or malicious intent, the IRS will impose penalties, because the misclassification affects tax revenue. In most cases, the employer will need to pay 100% of the matching Social Security and Medicare tax contributions and possibly a portion of the employee’s contribution. The company is also liable for a percentage of the employee’s wages.

If the IRS determines that the employer purposely misclassified the individual, there may be additional fines and potential imprisonment.