The COVID-19 pandemic created several operational, financial, and human resource challenges for businesses across the Front Range. The combination of forced business closures and stay-at-home orders required many Denver companies to modify operations, including the transition to a remote work environment. In fact, it was discovered in a recent survey that almost 70% of full-time employees were working from home. The transition required several changes to daily business practices including reliance on virtual meeting software and a renewed emphasis on cybersecurity. At the same time, it also blurred the lines between regular employees and independent contractors making it more difficult to accurately classify new workers. The absence of common financial and behavioral controls associated with “business as usual” led many to make mistakes when classifying workers. To help clients, prospects, and others understand the distinctions, Hanson & Co has provided a summary of the key details below.
Reviewing Worker Classification
When reviewing whether a worker is properly classified it is essential to understand the defining elements which make a worker an employee or independent contractor. An individual is considered an employee when the business controls the work assignment and the timeframe for completion. Whereas an independent contractor is an individual in a separate business that provides specific services.
As alluded to above, the principal characteristic in determining the appropriate classification is the nature of the degree of control and independence in the relationship. The IRS encourages employers to evaluate three specific criteria when deciding, including:
- Behavioral Control – Consider the control the business has over the worker’s behavior. For example, does the company has the right to assign work tasks, set the delivery timeline, and mandate how the work should be completed?
- Financial Control – Does the employer control the financial aspects of the worker’s job? This may include when the worker is paid, how often, which expenses can be reimbursed, and who is required to provide the tools (i.e., computers, software, ancillary supplies) necessary to complete assigned tasks.
- Relationship Between Parties – Business relationships are commonly outlined in writing and include specific details about how and when certain things, are expected to occur. For example, are there written contracts or employee-type benefits offered (i.e., retirement plans, health insurance, paid time off, etc.) Is the work performed a key aspect of the business, or simply provided as needed for the organization?
These answers to these questions are designed to bring focus to an otherwise blurry issue. It is entirely possible that a worker will appear to be an employee when evaluating behavioral control, but not when assessing financial control. The truth is that each situation is different and requires an employer to evaluate the entire relationship and consider the extent to which the right to control and direct a worker’s activity is vested in the company or by the worker independently.
Consequences of Misclassification
Misclassification results in the underpayment of taxes for both the employee and employer. If a business misclassifies a worker, then it could be held liable for the outstanding employment taxes including income Social Security, Medicare, and unemployment taxes. For those with a significant number of misclassified workers, the tax consequences could be significant.
When a misclassification has occurred, a business can come into compliance with IRS regulations through the VCSP. Program participation not only ensures the proper collection of employment taxes but provides partial relief from back tax payments and other benefits. This includes the requirement to only repay 10% of outstanding employment taxes, waiver of penalties and interest on missed payments, and protection from an employment tax audit for misclassified workers in prior years.
Denver and Colorado businesses should regularly review worker classification procedures to ensure compliance with federal rules and regulations. Unfortunately, misclassification can result in a costly tax bill which includes penalties and interest for late payment. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Hanson & Co can help. For additional information call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.