The gig economy has changed how both businesses and workers operate. While businesses may employ more freelance workers, that doesn't change the importance of properly identifying employees versus independent contractors for tax and legal purposes.

In general, businesses that classify workers who could be considered independent contractors as employees won't face any legal or tax ramifications. It's when businesses incorrectly classify employees as independent contractors that they face back wage payments, unpaid payroll taxes, and penalties from the IRS.

Independent Contractor versus Employee: How to Tell the Difference

The IRS recommends that businesses consider three categories for determining when a worker is an independent contractor versus an employee:

• Behavioral control: How much control does a business have over when and how a worker does their job?
• Financial control: How much does a business direct the financial aspects of a worker's job, such as who provides tools and supplies? How does the business pay the worker?
• Relationship: What is the relationship between the parties? Does the business provide the worker with a written contract or benefits such as a pension plan, insurance, or vacation pay? How does the work factor into key aspects of the business?

In general, the entirety of a worker's situation will factor into the decision. That a business gives a worker a 1099 isn't, on its own, enough to establish that the worker isn't an employee.

Intentional versus Unintentional Misclassification

When a business misclassifies a worker as an independent contractor when the worker should be considered an employee, the business faces serious penalties. This can include not just back payments but also penalties and fines.

As an employer, a business has certain responsibilities to employees for tax purposes. This includes withholding and paying income taxes, unemployment taxes, Social Security, and Medicare.

The fines and penalties that an employee has to pay come down to whether the misclassification was intentional or unintentional. Businesses found to have intentionally misclassified workers face significantly steeper penalties and fines than those who accidentally misclassified workers.

If you have questions about how employee classification can affect your tax liability, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.