In this day of work from home, the gig economy, and demands for more flexibility in the work-life balance, it is becoming harder to determine if the people that work for you are properly classified as employees or independent contractors.  It goes without saying that most owners of smaller businesses would prefer to treat their workers as contractors and not employees, and the reasons for doing so are pretty easy to understand:

• Contractors are easier to terminate and their termination carries less risk;

• The company does not have to withhold income taxes from the checks given to contractors;

• The company does not have the burden of paying payroll taxes associated with employees; and

• Contractors are not typically provided expensive benefits such as health insurance and paid time off.

While that sounds very good for the bottom line, it is a trap for the unwary, and often a very expensive trap.  That is especially true now with the Internal Revenue Service (IRS) continuing its efforts to collect payroll taxes and cracking down on business owners who misclassify workers as contractors instead of employees.  A failure to properly classify workers can result in a requirement to pay back taxes together with significant fines and penalties even if the misclassification was unintentional.  Those responsible for the withholding of payroll taxes within an organization can also find themselves personally liable for the uncollected taxes.

The test for determining whether a worker is a contractor or employee is very broad – a worker is a contractor only if the payer for the work can only control the result of the work and not when or how it will be done.  Contractors typically have their own employees, advertise their services, send invoices for their services, have their own tool, set their own hours, keep business records, and conduct themselves as their own boss.  Employees, on the other hand, spend the bulk if not all of their work time on the company’s property or in its facilities, are directed in how, when and/or where to do their work, are subject to workplace rules governing things such as breaks and dress codes, are given training by the payer, have company email accounts, and are provided benefits such as paid time off. 

Many times, the line between the two blurs; however, workers are generally presumed to be employees, and the burden of showing otherwise is on the company.  There is a widespread belief that if a company issues 1099s for its workers, the IRS will not challenge the classification given by the payer.  The reality, however, is that both state and federal government agencies would rather collect taxes from a single employer rather than trying to collect from many contractors. 

When the IRS knocks on your door, it will take a substance over form approach to determine whether workers are employees or truly contractors looking at the overall economic reality of the workplace.  If there is any doubt as to the classification, do not expect the IRS to be on your side.  Therefore, if you find yourself thinking you can improve your bottom line by “1099’ing” your workers, get solid legal and tax advice first before the IRS knocks on your door.