The seemingly simple question of “employee or independent contractor?” is often the subject of many complicated and costly audits. As the gig economy continues to grow, employers should familiarize themselves with the distinct characteristics of which is which in order to steer clear of misclassification penalties.
The best way to avoid misclassifying workers is to understand the defining characteristics of independent contractors — and then treat them as such.
Use this handy checklist to help you identify independent contractors and understand how they are different than employees.
Independent Contractors Checklist
Use this list to help determine if you or the person who does work for your business should be considered an independent contractor.
An independent contractor:
- Pays self-employment taxes (Social Security and Medicare).
- Is trained in their profession.
- Can work with many employers at one time (different clients).
- Controls when, how and where the work is done.
- Negotiates rates on a per-job basis.
- Uses own tools and equipment to perform the work.
- Does not receive employee benefits.
- Works on a profit/loss basis.
- Does not receive overtime pay.
Defining an Independent Contractor
The IRS says an individual is an independent contractor if the payer (employer) has the right to control or direct only the result of the work, not what will be done and how it will be done.
Unlike independent contractors, employees are protected by various employment laws, including:
- Fair Labor Standards Act (FLSA)
- Family and Medical Leave Act (FMLA)
- Occupational Safety and Health Act (OSHA)
- Americans with Disabilities Act (ADA)
- Unemployment compensation
- Workers compensation
While some business owners purposefully misclassify employees to avoid paying for taxes, overtime, benefits, unemployment and workers’ compensation, others do so unwittingly due to simple errors or misunderstanding.
There’s a lot at stake when it comes to classifying employees. It starts with fines, back payments, steep legal fees, and can end with harm to the employer’s reputation, and even jail time when mistakes are made, unintentionally or not. Penalties can be steep. If misclassification is unintentional, an employer can be charged a $50 fee for each W-2 not filed, 1.5% of the employee’s wages plus interest, 40% of the employee’s FICA (Social Security and Medicare) contributions and 100% of the employer’s matching FICA contributions.
Misclassify on purpose and it gets more serious with greater fees and fines. There could be up to $1,000 in criminal penalties per misclassified employee, and up to 1 year in prison. The person who made the error in misclassification can also be held personally liable.
1099 Filing Thresholds
So come tax time, who do you distribute a Form 1099 to? Any non-corporate service provider that is paid $600 or more for the year should receive a 1099.
- $10 in royalties
- $600 or more for services (including materials)
- $600 or more in rent
- $600 or more in “other income” such as prizes
- $600 or more in medical or health care payments
- $600 or more to attorney
There are some business payments you may make that do not get reported on Form 1099 even though they might be taxable to the recipient.
- Payments to corporations (both “S” and “C”)
- Payments for merchandise, freight, storage, phone service
- Employee Wages (these go on W-2)
- Payments made by credit card (these go on 1099-K)
- Canceled debt (this goes on 1099-C)
Independent Contractors Facts and Figures
- 130+ million U.S. workers are protected by the FLSA.
- 57.3 million people freelanced in 2017.
- Part-time and full-time freelancers represent 35% of the U.S. workforce.
- 1 in 5 jobs is a contracting job in the U.S.
- 6,000+ NJ employees were misclassified in 2017.
As always, should you have any questions or concerns regarding your payroll situation, please give Abacus Payroll, Inc. a call at 856.667.6225.