Rick Van Valkenburgh, CPA, is a Tax Partner at Larson & Company. He specializes in tax planning and preparation for small businesses and fast-growing companies.

A common issue for small businesses is the incorrect treatment of employees as independent contractors. Whether done innocently or intentionally in an effort to avoid employment taxes, this incorrect employee classification can have catastrophic consequences.  If the IRS reclassifies an independent contractor as an employee, the employer could be held responsible for the employment taxes that should have been withheld from the employee’s wages as well as the employer’s share of employment taxes.  There would, of course, also be penalties and interest assessed.

In order to avoid incorrectly classifying an employee as an independent contractor, please consider the following:

Behavior Control
    1. An employer has the right to control how an employee does the work
    2. You tell your payees where to be, when to be there, and what to do when they’re there
    3. The work must be done personally by your payees
    4. You provide training
Financial Control
      1. There is generally no risk of loss to your payees for the work they perform
        • They are not required to pay any business expenses personally
      2. Your payees generally don’t have their own equipment, tools, materials, etc
      3. They often don’t (and sometimes can’t) work for anyone else
      4. Your payees are usually paid either hourly or salaried instead of by the job
Relationship
    1. There is no written contract designating your payee as an independent contractor
    2. You provide benefits
    3. You maintain an ongoing business relationship
    4. The payee’s services are an integral part of your company’s continuing operations
Other Considerations
    1. Less important but considered nonetheless:
    • Employer’s right to discharge the payee
    • Payee’s right to terminate the business relationship
    • Part-time or full-time work requirements
    • Work required to be done on employer’s premises
    • Setting of hours to do the work
    • Setting order of sequence of the work
    • Interim oral or written reports requirement

These considerations assist the IRS in making a determination of employee status.  No one item on the list above by itself will clearly determine the status of a payee. However, if some of the above conditions exist in your contractual agreements (written or unwritten) with those who provide services for your company, you may want to reconsider either paying them as an employee or changing the agreement.

Below are a couple of links to the IRS and State of Utah for some guidance on this issue.

IRS Publication 1779, Independent Contractor or Employee…​

Utah Department of Workforce Services Guidelines for Employment Status (Independent Contractors)

For more assistance with small business accounting and payroll issues, contact your Larson advisor today.