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Classifying Workers as an Employee or Independent Contractor

An individual’s classification as an employee or independent contractor determines an organization’s responsibility regarding FICA, income tax withholding, and employer benefit plans.  Misclassification can lead to significant penalties, so it is important to understand the difference.

Independent Contractors

Workers are classified as contractors if:

  • They normally set the order and sequence of work.
  • They set their hours of work.
  • They work for others at the same time.
  • They are paid by the job.
  • They furnish their own tools/equipment.

The following payments are usually classified as contract labor transactions:

  • Honorariums paid to guest speakers.
  • Stipends (periodic payments) made to band members.
  • Honorariums and stipends seldom—if ever—have income tax withheld.

Contract labor payments are made at gross amount with no federal, state, or FICA withholding. It is the contractor’s responsibility to file and pay taxes.

If a contract agreement is for an extended period of time and/or for specific projects, we advise both the employer and the contractor to sign a written agreement describing the nature of the work and the compensation arrangement. A simple Contract Agreement is provided below.


Employees

Workers are classified as employees if:

  • They maintain continuous, standard hours of employment.
  • They are subject to dismissal.
  • They can quit at anytime without penalty.
  • They receive business-expense reimbursements.
  • They must follow the organization’s work instructions.
  • They receive on-the-job training.
  • They receive routine payments of regular amounts.

Generally, the individual is considered an employee if the organization has the legal right to control both the work and how it is done.

When a person is paid as a regular employee:

  • The employer withholds and pays all the necessary employee income taxes as required by the IRS. These taxes include federal income tax, state income tax, and FICA (social security and Medicare taxes).
  • The employer pays employer taxes, including FICA. (Churches are exempt from FUTA (federal unemployment) and SUI (state unemployment insurance) taxes.)
  • Your payroll processor will manage these calculations and transactions.

Full-time employees and part-time employees are defined by the required hours and earned benefits that are unique to each organization. We recommend hiring part-time employees for less than 30 hours per week.  Generally, the government mandates employers to provide comparable health insurance coverage to all employees who work at least 30 hours per week.   Health insurance carriers generally use the 30 hour per week threshold when determining health insurance eligibility as well.

Want to learn more about classifying your workers?  http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

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