We are not accountants. We aren’t even tax attorneys. For questions beyond the information we provide below, we recommend reaching out to incredibly intelligent accountants at Incite Tax.
The Two Tax Designations
Paid staff members in the United States fall under one of two categories: Employees or Independent Contractors. When someone is an employee, the business (employer) is responsible for paying the wage taxes on behalf of the employee and matching the employee’s federal tax contribution. Alternatively, when a staff member is an independent contractor, the contractor is responsible for paying wage taxes and the business has no additional tax contribution liability. While this is a simplified explanation, for these purposes, it essentially means that the Federal Government makes more money from taxes from businesses who “employ” staff versus businesses who have independent contractors. Thus, the IRS has an interest in making sure staff fall into the proper tax designation (employee or contractor).
How Much Control Do You Have?
This becomes important primarily when the IRS audits a business. The IRS will look at the staff and how the business pays that staff. The IRS applies a multi-part checklist that essentially gauges the amount of control the business maintains over the staff member. The more control, the more likely the IRS will designate that staff member an employee. The less control, the more support the business has for the IRS to designate the staff member as a contractor.
Sliding Scale Test
The difficulty is that there is no definitive test for determining the proper tax designation (employee vs contractor). There are a couple of bright line rules. To name a couple, if you provide benefits, like worker’s comp insurance, to your staff, then they are automatically employees. Or, if you pay for certifications or provide limited vacation days each year, then they are automatically employees. Otherwise, it is a sliding scale. The IRS will always try to slide the scale toward “employee” designation. If it is determined that you have been paying staff as contractors, when you should have been paying them as employees, there can be serious monetary consequences.
As such, it is very important to be as clear as possible in your contractor staff agreements that the Agreement is meant for a contractor. This is not to say that simply calling someone a contractor will not automatically support a tax designation as a contractor. However, it is one element to help swing the sliding scale test away from “employee” designation.