Every company faces this dilemma no matter how big or small. There is always a cost involved when it comes to hiring new people, and we are not talking only about pay and perks here. While companies these days consider the option of independent contractors and remote outsourcing, they must also understand where they stand from the tax point of view with both these options. The IRS (Internal Revenue Services) bases its tax on the categorization of employees and contractors. And as a company you need to be aware of your obligations before you hire employees or independent contractors.
Contrary to popular opinion, whether a worker is an employee or an independent contractor is not decided between the worker and company. It is decided by their categorization by the State and Federal governments. And their interest is of course money. Employee taxes such as payroll taxes and Social Security and Medicare must be withheld for employees and not independent contractors. Hence the companies may often want to classify an employee as independent contractor to save on these employee taxes. The government on the other hand prefers to label the worker as an employee. The more the number of employees, the more taxes goes to government coffers.
Before deciding on the category, degree of control and independence must be studied in depth. Here are the criteria shared on IRS’s website that help you in defining an employee:
Behavioral: What is the control of the company over what the worker does on their job? Does the company control or have the right to control the worker’s job? Does the company have the right to direct the worker as to where, when and in what fashion the job is completed?
Financial: Who controls the payments made to the worker? This includes how the worker is paid, in which way are the expenses of the worker reimbursed, who provides the tools for the trade, who sets their working hours, whether they work full time or part time for the company, whether they provide services that enable the day-to-day functioning of the company etc.?
Type of Relationship: What is the kind of relationship between the employer and the worker? What is the nature of contracts between them? What kind of benefits does the worker enjoy? Do they include insurance, paid leaves, pension and others?
While these criteria are pointers, it must be understood that there are really no magic factors at play here. Some criteria may make a worker seem like an employee and others an independent contractor. A company has to take that decision in a consolidated manner. No one factor weighs more than the other in this regard. And often the categorization may seem subjective as well.
Employers need to understand this categorization well so that they do not end up making mistakes that may cost them in the long term. They can avoid erring on the audit, fines and taxes front if they appropriately classify the workers and ensure that all federal and state tax and other obligations are fulfilled.