For some business owners, determining whether a worker is an employee or an independent contractor can be tricky. Generally, you must withhold income taxes, withhold and pay social security and Medicare taxes and pay unemployment tax on wages paid to an employee. However, you don’t generally have to withhold or pay any taxes on payments made to independent contractors.

There is a misconception that you may be able to choose which classification works best for your company. In reality, however, the facts and circumstances impose the worker status. In determining whether the person providing a service is an employee or an independent contractor, you must consider all information that provides evidence of the degree of control and independence. You’ll need to answer these four questions:

1. Does the company control or have the right to control what the worker does and how the worker does his or her job?

2. Are the business aspects of the worker’s job controlled by the payer? Examples include how a worker is paid, whether expenses are reimbursed and who provides tools/supplies.

3. Are there written contracts or employee-type benefits like a pension plan, insurance, vacation pay?

4. Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. No set number of factors makes the worker an employee or an independent contractor and no single factor stands alone in making this determination. The concept is to look at the entire business 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.

Failure to properly classify a worker in your business will cause significant trouble for your business with the Internal Revenue Service, the Employment Development Department and the California Board of Equalization. An improper classification of an employee as an independent contractor will cause you to pay back payroll taxes and potentially be personally liable for the employer portion of the payroll tax as a penalty, called the Trust Fund Recovery Penalty. We’ll discuss this in a later post, but it will cost significant amounts of money and could cause you to shut down your business.

One major issue we find is when a State Auditor from the Employment Development Department visits a place of business and tells the owner or other key employee that their independent contractors have been reclassified and they need to sign an agreement to such right away or they will shut the business down. DO NOT SIGN! without first consulting an tax attorney or you will be opening yourself to significant costs and penalties.

The Stevenson Law Group has experience in assisting clients in employment tax issues. Our services include:

1. Drafting employment and independent contractor contracts to assist in ensuring your client is properly classified.

2. Advising on the proper procedures and compliance requirements to ensure you can adequately survive an audit.

3. Provide tax opinion letter that may be used to absolve your business of penalties that may be assessed due to tax advice given by our office.

4. Representation before the Employment Development Department, Board of Equalization, Franchise Tax Board or IRS with regard to employment/payroll tax issues.

If you are interested in learning more or for a free consultation please contact our office at (619) 330-9409 or email at info@stevensonlawgroup.com.