During tax season, the IRS focuses on violations of tax laws that can result criminal prosecution. One type of violation the IRS is cracking down on is the classification of employees v. independent contractors for tax purposes. Here’s what you need to know to ensure you avoid violating the rules.
To determine whether someone falls into the category of independent contractor, the IRS looks at facts that show the degree of control and independence that the worker exercises in the relationship. These facts fall into three general categories, which are broken down into more detail below.
Behavioral Considerations – Under the behavioral category, the IRS looks at multiple factors, including:
- Type of instruction given: Some examples of this are when and where to work, what tools to use, how to hire other workers, which workers perform which work, etc. The more instruction given, the less likely worker should be classified as an independent contractor.
- Degree of instruction: The more detail, the less likely the worker is considered an independent contractor.
- Evaluation: If there is an evaluation of how the work is performed, that points towards an employee classification; conversely, if the evaluation only measures the end result, the worker is more likely to be considered an independent contractor.
- Training: If on-the-job training is provided, this tends to be strong evidence that the worker is not an independent contractor.
Financial Considerations – When determining whether a worker is an independent contractor, the IRS look at facts related to the financial aspects of the arrangement. Financial aspects of the relationship are important in determining the degree of control. Some questions the IRS may ask are: does the worker have a significant investment in the work? Does the worker have unreimbursed expenses? Does the worker have an opportunity for profit or loss? Are the services of the worker available to the general market? And, finally, is the worker paid a flat fee for the job? The more the answers to those questions are “yes”, the more likely the worker qualifies as an independent contractor.
Nature of the Relationship – Lastly, the IRS considers the nature of the relationship. Typically, if the worker enjoys employee benefits (i.e. insurance, paid vacation, etc.), the worker is less likely to be an independent contractor. The IRS also takes into account the permanency of the relationship and whether the services are a “key activity” of the business.
If you violate the rules and misclassify a worker, you could be facing some serious consequences. Willful violations of this and other tax laws can lead to prosecution, jail, restitution and other monetary penalties. While these rules may seem minor, the IRS is starting to focus on violations of this issue and consider willful violations tax evasion.