How to determine whether someone working for you is an employee or an independent contractor? The difference can be incredibly important and making the proper distinction in the beginning can save you a lot of money in the long run.
Why Does This Matter?
First, it’s important to understand the difference. When we are talking about independent contractors and employees, we are basically talking about their tax status in your business. If you have ever worked for someone else you were most likely an employee. You were paid every other week or every two weeks and your employer took taxes out of each paycheck. Alternatively, when you work for yourself, or you are self-employed, you are responsible for paying your own taxes.
When you own your own business, like a gym, and you pay someone to work for you, you need to make sure you make the correct tax designation. So, how do you determine the proper distinction?
3 Part Test
The IRS applies a three part test when determining whether the person you are paying is an employee or not. Unfortunately, this test is not full of bright line rules. Instead, the IRS will look at these three broad criteria individually. Essentially, if any of the three point toward an employee, you need to designate the person an employee and pay their employment taxes.
Behavior Control, Financial Control, and Relationship
First, look at behavior control: do you train your workers, direct their tasks, set specific hours, and/or dictate how the work should be completed? If so, they are an employee.
Second, look at financial control: do you pay your worker a salary? Do you pay him/her a regular standard wage for the work they complete? If so, they are an employee.
Finally, look at the type of relationship: do you provide your worker with benefits? Do you plan to keep your worker around for a long time? Do you set their schedule and pay them hourly? If yes to any of these, then they are likely an employee.
The primary issue we see is designating someone an independent contractor, paying them for years, and then getting audited by the IRS. The IRS designates them an employee and forces you to pay all of the unpaid employment taxes, plus fines. This can be devastating.
If you need help running through the IRS criteria and getting a better understanding of making the proper tax designation for your workers, reach out. We are here to help.