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Use Care in Classifying Contractors vs. Employees

Human Resources

The growth of independent contractors in the workforce has prompted some to call the new, post-recessionary U.S. work world the “1099 Economy,” referring to the name of the tax form filed by independent contractors.

An estimated 10.3 million U.S. workers are independent contractors, according to 2010 U.S. Census Bureau data, and all indications are that number is rapidly growing.

But, the growth of independent contractors has led to growing scrutiny by the Internal Revenue Service, which is seeking out companies that are misclassifying employees as independent contractors to avoid paying taxes and employee benefits.

Here are two steps a company should take to avoid the penalties, back taxes and interest that can come from misclassifying a worker as an independent contractor.

Be careful to make the correct classification

Get the classification of workers right the first time and continually monitor independent contractors so you are aware if a contractor’s relationship with your company changes and necessitates a re-classification as an employee.

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The Internal Revenue Service uses a 20-part “right-to-control” test to determine whether a worker is an independent contractor or an employee. The more control a company has over when, where and how work is performed, the more likely the worker is an employee and not an independent contractor. Refer to the IRS website to review a list of all 20 elements that the IRS uses to determine whether a worker is an independent contractor vs. an employee.

Don’t be afraid of reclassifying your workers

While the IRS is turning up the level of scrutiny on companies that misclassify their workers as independent contractors, they also are offering leniency for those that address the problem. The Voluntary Worker Classification Settlement Program recently was expanded by the IRS and offers companies a way to avoid stiff penalties.

“Employers accepted into the program will generally pay an amount effectively equaling just over 1 percent of the wages paid to the reclassified workers for the past year,” according to the IRS. The program eliminates interest and penalties, and assures that employers will not be audited on payroll taxes related to the reclassified workers’ prior work.

When executed correctly, the independent contractor relationship can have benefits for both workers and companies.

Independent contractors have greater flexibility in work schedule and location and are able to pursue multiple entrepreneurial opportunities. Companies gain an on-demand workforce that can scale with the ebb and flow of business without the long-term costs and commitments of hiring full-time employees.

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