It is less expensive to classify a worker as an independent contractor rather than an employee. Moreover, small business owners find it very difficult to deal with the administrative requirement of hiring employees. There is always the temptation to classify employees as independent contractors because of the relative ease of dealing with the contractor status.

The problem is simplicity should not be the deciding factor of how workers should be classified. There are consequences if the IRS decides to reclassify a worker as an employee. If the IRS reclassifies an employee, you will be liable for employment taxes, penalties and interest on failure to withhold and remit required taxes.

Business relationships with workers

When you hire someone to do work on your behalf, you must first understand the business relationship that exists between you and that person. Classification as an independent contractor or employee determines what taxes the employer is responsible to pay. There are three main factors used to determine business relationships namely:

• Behavioral factors
• Financial factors
• Permanency of the relationships

Behavioral factors

Behavioral factors measure the extent to which a business owner can control the workers behavior. Example of control factors are:

• Controlling the time the individual works is an indication of an employer/ employee relationship.
• The extent to which an individual is required to use the employer’s method versus their own could be another indication.

Financial factors

Financial factors focus around how much the hired individual can control their own earnings. Financial factors include:

• The ability of the individual to provide similar services to other members of the public. When the employer is the sole benefactor of services provided by the worker, then the relationship could potentially be classified as an employer/ employee relationship.
• The pay arrangement could also be an indicator of an employer/ employee relationship. If as a business owner, you guarantee a regular hourly wage or salary with fixed work, then the individual is more an employee than independent contractor.

Permanency of the relationship

The length of time the business relationship could also be a clue as to the type of relationship. If you hire a person and expect the relationship to continue indefinitely, rather than for a specific project or time, then the relationship could qualify as an employer/ employee relationship.

In summary, the relationship between business owners and hired help should be clearly defined before work begins. It is helpful to have a written contract which clearly defines the type of relationship. A contract cannot be used to wrongly classify a worker but it is a way to clearly state the relationship and responsibilities that exists between both parties.