Myth About Payroll Taxes: Transforming Employees Into Independent Contractors To Save On Payroll Taxes Is Easy

Sep 21, 2022

Myth: Transforming Employees Into Independent Contractors To Save On Payroll Taxes Is Easy

Reality: You probably know that it costs less to use an independent contractor than to have an employee on staff. The reason: the cost of payroll taxes, along with insurance and benefits, apply only to employees. But don’t think you can simply reclassify a worker who’s been your employee as an independent contractor. The IRS, as well as other government agencies, are on the lookout for just such action.

According to the Harvard Business Review, the use of Independent Contractors has increased by 40% in the last decade. According to the Labor Department, so many employees are misclassified because companies are not knowledgeable about how to classify their employees according to labor and workplace laws. The issue of misclassification of Independent Contractors has been around for a while. According to the IRS, they primarily view workers as Independent Contractors when they should be classified as W-2 Employees.

The classification of a worker depends on many factors, most of which boil down to a matter of control. Essentially, if you have the right to say when, where, and how work gets done, you’re likely dealing with an employee. The IRS uses three categories of factors to assess the degree of control: behavioral, financial, and type of relationship. Many states, including California, use an ABC test:

1. The worker is free from the control and direction of the hirer in connection with performing the work.
2. The worker performs work outside of the usual course of the hiring entity’s business.
3. The worker is usually engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

According to the IRS and court precedent, the following items indicate that a worker is an employee:

• Level Of Instruction: If the company directs when, where, and how work is done, this control indicates a possible employment relationship.
• Degree of Business Integration: Workers whose services are integrated into business operations or significantly affect business success are likely to be considered employees. 
• Services Rendered Personally: Companies that insist on a particular person performing the work assert a degree of control that suggests an employment relationship. 
• Set Hours Of Work: People whose hours or days of work are dictated by a company are apt to qualify as its employees. 
• Full-time Required: Full-time work gives a company control over most of a person's time, which supports a finding of an employment relationship. 
• Furnishing Tools and Materials: Workers who perform most of their work using company-provided equipment, tools, and materials are more likely to be considered employees. 

According to the IRS and court precedent, the following items indicate that a worker is a contractor:

• Investment In Facilities: Independent contractors typically invest in and maintain their own work facilities.
• Realization Of Profit Or Loss: A worker who can realize a profit or suffer a loss providing the services is generally an independent contractor.
• Working For More Than One Firm At A Time: People who simultaneously provide services for several unrelated companies are likely to qualify as independent contractors. 
• Making Service Available To The General Public: If a worker makes his or her services available to the public on a regular and consistent basis, that indicates independent contractor status.

Hiring, Supervision, & Paying Assistants: If the worker hires and supervises others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, this indicates independent contractor status.