FS-Blog-400x210 copy 10.jpgAs an employer or payroll tax specialist, you know how important it is for taxable information to be accurate. However, sometimes it may feel like there is a thin line between distinguishing an individual as an employee or an independent contractor. Incorrectly classifying workers is a liability, and there are different employer requirements for employees and contractors. For example, independent contractors only have to complete a Form 1099-MISC at the end of the year, but employers have to withhold taxes, provide W-2s and meet several other requirements if a worker is classified as an employee. Here's everything you need to know to make the right classification decision.

How to Determine Worker Status

The best way to determine the status of a worker is by analyzing the employment situation and taking all factors into account. If you use the same processes as the IRS or court system would when classifying workers, you'll be less likely to have incorrect classification issues.

Common Law Rules

Factors that are typically taken into account by the IRS are called Common Law Rules. These rules help to clarify the relationship between the worker and employer. Unfortunately, there is no sole factor that determines whether a worker is an employee or an independent contractor, and all factors do not need to be present in any given situation. Evidence of incorrect classification generally falls into these categories:

Behavioral Control

The extent to which the person receiving services has the right to control the service provider on how the worker does their job is a good indication as to whether or not they are an independent contractor or an employee. A worker is likely an employee if they've received:

  • Instructions - Have they been given business instructions that control how work results are achieved?
  • Training - Has the worker received company training or developed his/her own methods?

Financial Control

Whether or not a business is able to control financial aspects of a worker's job is often an important factor in determining worker status. Analyze these facts:

  • Extent to which the worker has business expenses that aren't reimbursed -Do they have fixed, ongoing costs?
  • Extent of worker's investments - Have they purchased equipment or other materials?
  • Financial risk - Does the independent contractor have an opportunity for profit or loss?

Type of Relationship to Each Other

The type of relationship a worker has with a business is one of the most significant factors to consider when classifying workers. It's important for a business to weigh factors like whether the relationship will continue and if the work performed is a major aspect of the company. When searching for evidence, refer to:

  •  Written Contracts -Though contracts are not solely sufficient to determine worker status, it's helpful to have written agreement of worker status
  •  Employee Benefits - Independent contractors generally do not receive employee benefits and perks such as insurance, vacation or sick days 


You may be curious about the risks of incorrectly classifying workers. There are less employer requirements involved with classifying a worker as an independent contractor, so incorrect classification can lead to issues with the IRS. For example, if the workers paid as contractors are later determined as W2 employees by the IRS, you will be responsible for paying the taxes that were not withheld. Risks of incorrect worker status include:

  • Monetary Penalties
  • Employer Income Tax Liabilities
  • Workers Filing Form 919 - a tax form used to report uncollected Social Security and Medicare taxes

When in doubt, label workers as employees. If you need assistance determining the status of your workers, contact Future Systems today.

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