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Contractor or Employee: Make sure you classify correctly to avoid risks

6/22/2022

 
By: Nancy Mehlberg  - CVB EA, Principal, SVA Certified Public Accountants
Properly classifying individuals who perform services for your company is critical to avoid penalties and issues with the Department of Labor (DOL) and the Internal Revenue Service (IRS). Misclassifying can land you in big trouble as the IRS has stringent definitions to determine which is the appropriate classification.

 Independent Contractor vs. Employee
According to the IRS, the definition of an independent contractor or an employee depends on the relationship between the worker and the business. Generally, there are three categories to examine:
  • Behavioral Control
    Does the company control, or have the right to control, what the worker does and how the worker does the job?
  • Financial Control
    Does the business direct or control the financial and business aspects of the worker’s job? Are the business aspects of the worker’s job controlled by the payer? Examples are how the worker is paid, are expenses reimbursed, who provides tools/supplies, etc.
  • Relationship of the Parties
    Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

When hiring independent contractors, always have a written contract that outlines the specifics of the work expected and the timeframes. Longterm work or extended deadlines will bring into question if the individual should be an employee.

An agreement (or contract) between a business and an individual does not mean they are truly an independent contractor. They must meet the requirements of an independent contractor and the appropriate taxing authorities must agree that they meet the requirement.

How Can a Potential Issue be Brought up for Examination? 
  • An independent contractor applies for unemployment when they are no longer needed by your organization.
  • An independent contractor receives a 1099 and a W-2 in the same year. Although there can be certain situations that this can occur, it can also be a red flag.
  • An independent contractor submits a worker’s compensation claim. There are situations where independent contractors can be covered under a company’s worker’s compensation policy, however this will lead to a review of the facts.

Red Flags Indicating You May Have an Issue
When working with your independent contractor, here are 5 things you need to avoid:
  • Do not let your independent contractor use company equipment or work onsite unless the job absolutely requires it.
  • Do not provide a company email, title, or invite them to employee meetings.
  • Do not prohibit them from working with other companies or require full-time work for your company.
  • Do not pay weekly, biweekly, or monthly – require invoices for payment of services.
  • Do not give additional work after the project is completed without signing a new contract.

What Happens if a Misclassification Occurs?
An employer is required to withhold and pay income taxes, Social Security, Medicare, and unemployment taxes for each worker. If it is deemed that the individual is an employee, the underpayment of these taxes can result in large balances due as well as penalties from the IRS.

Do Your Due Diligence
If you have independent contractors, consult with an outside advisor to have them review your contracts. Taking the time for a review could save you significant dollars in the future. Better safe than sorry!



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  • JOIN
  • Membership
    • The benefits of joining
    • Member directory >
      • Member Spotlights
      • Talent Solutions Directory
    • What we do >
      • Talent >
        • Ranking Milwaukee County Schools
        • Education recommendations
        • Technology Education & Literacy in Schools (TEALS)
        • Career-based learning experiences
      • Growth
      • Livability
      • Equity
      • Peer metro comparison
    • Cost saving programs >
      • Health insurance plan
      • Office supply discount program
    • Events >
      • 2021 All Member Meeting
      • Diverity, Equity & Inclusion Summit
      • Talent Solution Series
      • Emerging Leaders Series
      • Global Business Insights Series
      • Member Orientation
      • Replay: The Business of MKE Series
      • Replay: Race Bridge Series
    • For members only >
      • Sponsorship
      • Advertising
    • Need more info?
  • Networks
    • Leadership Council
    • President's Huddle
    • Executive roundtable program
    • FUEL Milwaukee for young professionals
    • Future 50 Awards Program
    • Networking Forum for referrals
    • Region of Choice Initiative
    • Roundtables for high-growth companies
    • World Trade Association
  • Advocacy
    • Recent Legislative Wins
    • Miller Park economic impact study
    • Wisconsin State Legislature
  • Economic Development
    • Milwaukee 7 Regional Partnership
    • Resources for startups
    • Milwaukee Development Corp. >
      • Rebuild & Revitalize Program
    • Milwaukee Urban Strategic Investment Corp. (MUSIC)
    • Milwaukee EB-5 Visa program
    • Starting a business >
      • BizStarts
      • New business planning guide
  • Metro MKE
    • 2022 Navigate Business MKE
    • Business outlook survey
    • Economic trends
    • Local media listings
    • Major employers in metro Milwaukee
    • Metro Milwaukee demographics
    • Order a publication
    • Relocating a business
  • About
    • Board of directors
    • Council of small business executives
    • Staff
    • Milwaukee Commerce magazine
    • Press releases
    • Members of the media >
      • Recent Media Coverage
    • Scholarships for minority students