The Importance of Worker Classification for Businesses

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Many companies have experienced workforce fluctuations over the last few years. If your business has engaged independent contractors to address your shifting staffing needs, you’ll want to make sure these workers are properly classified for federal tax purposes. Failing to classify workers correctly could have serious implications for both your company and your workers. 

Here is a breakdown of the main consequences your company could face if your business misclassifies workers.  

Tax Obligations 

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one.  

If a worker is an employee, the company must:  

• Withhold federal income and payroll taxes. 

• Pay the employer’s share of FICA taxes on the wages, plus FUTA tax. 

• Pay any state tax obligations. 

Whereas if a worker is an independent contractor, these obligations don’t apply, but the company must:  

• Send the contractor Form 1099-NEC for the year showing the amount paid (if the amount is $600 or more). 

Legal Liabilities  

Employees have legal protections that independent contractors don’t. For example, workers’ compensation covers employee injuries on the job. Misclassifying an employee as an independent contractor could leave you exposed to lawsuits if they get hurt. 

As an employer, you must also have a “reasonable basis” for not treating the worker as an employee. Here’s what qualifies as a reasonable basis:  

• A past IRS audit of the employer that did not result in a penalty attributable to the employer’s treatment of a worker as an independent contractor. 

• A long withstanding, consistent practice in a significant segment of the employers’ industry of treating workers in similar situations as independent contractors. 

• Advice from a business lawyer or accountant familiar with the business or similar reasonable advice. 

This list covers some of the most common ways to determine reasonable basis as defined by the IRS, but is not exhaustive. If you have questions about whether your business has a reasonable basis to treat an employee as an independent contractor, you’ll want to contact your business tax professional to be sure.  

Employee Benefit Requirements  

Employees are entitled to certain benefits, like overtime pay and unemployment insurance, which employers are responsible for. If you classify someone as an independent contractor who should be an employee, you could be on the hook for these costs later. 

Getting it Right  

Taking the time to classify your workers correctly now can save you a lot of trouble and expense in the future. It’s a small investment that will ensure your business stays compliant and protects your bottom line. 

Have questions about worker classification and your business? Contact us to meet with our business tax and business advisory experts.