Use Caution When Classifying Workers

The construction industry has traditionally relied on a work force composed of full-time workers and independent contractors. Companies are generally required to withhold income taxes, withhold and pay FICA (Social Security and Medicare) taxes, and pay unemployment taxes on an employee’s wages. However, these obligations generally don’t exist when it comes to payments made to independent contractors.

Now, in an effort to capture delinquent taxes, the IRS is ratcheting up the pressure on taxpayers who misclassify employees as independent contractors. The IRS recently launched an audit initiative known as the National Research Project (NRP). NRP is randomly selecting 2,000 taxpayers for employment-tax examinations in 2011 and 2012. The audits are designed to measure compliance with employment-tax law and related reporting requirements and will also help the IRS select and audit future returns considered the greatest compliance risk.

To be on the safe side, you should familiarize yourself with certain factors the IRS reviews in determining whether a worker should be classified as an employee or as an independent contractor. Analysis of the entire relationship needs to be made. Important factors that provide evidence of the degree of control and independence fall into three categories:

Type of Relationship

The independent contractor’s services are typically for separate and distinct projects. However, employees also may be hired on a seasonal or project basis. What are the facts that show how the worker and business perceive their relationship? The permanency of the relationship, the existence of a written contract, the provision of employee benefits, and whether the services provided are considered a key activity of the business are factors to weigh.

Behavioral Factors

Independent contractors are generally not under the direct supervision and control of the business and do not receive detailed instructions about how work is to be performed. In short, the extent to which a business directs and controls what a worker does and how it is done is critical.

Financial Matters

How the worker is paid, whether expenses are reimbursed, and whether the business or the worker provides tools and supplies are all important financial factors to be considered.

If you are still uncertain as to a worker’s classification after weighing several factors in the three main categories, you can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will review the information and make an official determination.

If you need help in ensuring that your firm correctly classifies employees and independent contractors, please give us a call.