If you are starting a business, it is important to acquaint yourself with the relevant provisions of the Tax Code. And although this does not require a deep-dive into the minutia of statutes and IRS regulations, it does require some familiarity with the basics, one of which is how to classify your workers.

The people you hire will generally fall into one of two groups: employees or independent contractors. Classifying workers as employees obligates you, the employer, to report and withhold payroll taxes from their income. It also obligates you to pay a portion of those taxes—which include Social Security, Medicare, and unemployment insurance—on top of worker’s compensation. Independent contractors, on the other hand, are considered to be self-employed, and as a result, they are responsible for their own payroll taxes, FICA, and insurance, and do not implicate the same tax obligations as your employees. Given the significant administrative costs of taxes, the distinction is more than just a matter of labels.

But how do you know whether to classify a worker as an employee or an independent contractor? The IRS reduces the difference to three broad, but not exhaustive, criteria:

1. Behavioral Control – If you have the right to control how work is done, you are most likely dealing with an employee. This right is often exercised by giving instructions or training, conducting performance reviews, or mandating the use of company vehicles or uniforms.

2. Financial Control – Employees are generally paid a regular wage, whereas most independent contractors are paid a flat fee or by the job. Additionally, independent contractors are more likely to incur unreimbursed expenses and to invest significant sums in equipment. Furthermore, independent contractors can freely seek out business from anyone, whereas employees are bound to the company that hired them.

3. Relationship – Many times, the contract will identify the employment relationship. Other indicators include whether the employee is offered benefits—like a pension, vacation, or insurance—or overtime pay, which are generally not offered to independent contractors.

Although the distinction seems straightforward, be careful: none of these factors should be treated as dispositive. For instance, you cannot turn an employee into an independent contractor by simply refusing to exercise your right to control the work. The consequences of misclassifying a worker further encourage caution: back taxes and penalties could be enough to sink a growing business. That is why the professionals at Kondori & Moorad, LLP stand ready to help you navigate your obligations as an employer so that you can focus on better growing your business.

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