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States Double-Checking Employee Classification

May 15, 2009 - When an employer classifies an individual as an independent contractor some or all employer and employee tax payments are not required. The misclassification of workers causes state and local governments to lose hundreds of millions of dollars annually.

A large number of states are beginning to take a more aggressive approach to verifying the correct classification of workers. For example:

  • Ohio’s Attorney General recently announced an unprecedented collaboration among three state agencies to prevent misclassification and hold accountable those abusing the system. Read the press release.
  • In Kansas, the Department of Revenue and Department of Labor allow people to report suspected misclassification using an online form and the departments investigate all reports submitted.

What You Need to Know

The Internal Revenue Service (IRS) uses Common Law Rules to determine whether a worker is an employee or an independent contractor.

  • Behavioral – Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • Financial – Are the business aspects of the worker’s job controlled by the payer? These include things such as how the worker is paid, whether expenses are reimbursed, who provides the tools/supplies, etc.
  • Type of relationship – Are there written contracts or benefits offered, such as a pension plan, insurance or vacation pay?  Will the relationship continue and is the work being performed a key aspect of the business?

Businesses must weigh all of these factors when determining whether a worker is an employee or independent contractor.  The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally to document each of the factors used in coming up with the determination.

If after reviewing the three categories it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. 

There are consequences of treating an employee as an independent contractor. An employer can be liable for employment taxes for the misclassified workers and other penalties can also be imposed.

For More Information

Visit Paycor's new HR Support Center and search for "Contractor" in the Q&A Database under the "Knowledge" tab. 

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