The IRS estimates that employers continue to misclassify millions of workers as independent contractors, and state-level studies show that 10-20% of employers tend to misclassify at least one worker as an independent contractor. In order to prevent complications due to employee misclassification, companies must properly distinguish employees and independent contractors.

If a worker is an employee, then the company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages plus FUTA tax, and provide the worker with fringe benefits that they provide to other employees. There may also be state tax obligations.

However, not all of these obligations apply to a worker who is an independent contractor. For example, if the amount is $600 or more a year, then businesses will usually only send the independent contractor a Form 1099-MISC for the year showing the amount paid to the contractor.

Employers without a reasonable basis for their classifications may be held liable at both the federal and state level for back taxes, back wages, overtime, benefits, penalties, legal fees, and damages.

This article will further examine tax issues regarding the proper classification of employees and independent contractors.

Determining Worker Status

Under common-law rules, anyone who performs services for a company is considered an employee if the company has the right to assign work and control how that work is performed.² Regardless of whether the company gives that person freedom of action, he or she is considered an employee because the company ultimately holds the right to control how his or her work is performed.