In their ongoing search for a stronger bottom line, some companies try to get around costs associated with staffing by classifying employees as contract workers. This might seem like a clever work around, but in fact can get you into real trouble. With the government cracking down on employers who improperly classify their employees with sharp penalties, don’t allow your company to get caught in the crosshairs. Here are the key areas to look at in order to make sure you are making the right choice when it comes to classifying your workers.

The Difference Between W-2 and Contract Workers

As an employer, you need to know the difference between these two critical classifications. Generally, employers are obligated to withhold income taxes, withhold and pay Social Security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. You do not necessarily need to withhold or pay any taxes on payments to independent contractors. With that in mind, the difference in your costs of hiring and retaining different classifications of employees can make a real difference.

Determining the Business Relationship

Understanding the tax implications of the different business relationships is pretty intuitive from a profitability perspective, but the IRS holds very strict classifications of the different classifications. An independent contractor is defined as someone who is in an independent trade, business or profession who offers their services to the general public. That’s a pretty generic definition, so they go on to state that the general rule is an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.

Independent contractors are self-employed. They are in charge of their workflow and are responsible only for delivering on the end result as contracted. If you are influencing the way in which the work is done, then chances are that person should be classified as a W-2 employee.

Distinguishing Situations Define the Relationship

There are a number of situations that can provide evidence of the degree of control an employer has over their workers. These situations generally fall into three categories: behavioral facts, financial facts, and facts related to the type of relationship held by the employer and the employee. Behavioral situations include whether the company has the right to control what the worker does day in and day out, and how he or she does their job. Financial situations involve how compensation is used to control business aspects of the worker’s job, including how the worker is paid, whether expenses are reimbursed, etc.

Facts relating to the type of relationship held by both parties relate to whether there are written contracts or benefits involved, including pension plans, insurance, vacation pay and so on. Also important to note is whether the work performed is a key aspect of the business. If so, there is a high likelihood that worker should be classified as a W-2 employee.

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