Much of construction work is carried out through contractors — you win a contract to complete work and use subcontractors who have the skills you need. But it’s the classification of these workers — as employees or independent contractors — that determines whether you are responsible for withholding and paying payroll taxes. It’s an issue in many businesses and can become especially thorny in construction.
If your actions show an employer-employee relationship, your workers are employees no matter how you choose to describe them. Misclassification is a red flag to the IRS and regulators. The IRS and the Department of Labor in recent years have been cracking down on misclassification of workers as independent contractors and have entered into agreements with several states to coordinate enforcement.
Income tax, workers’ compensation, unemployment compensation, equal opportunity, and wage and hour laws and standards all have their own tests to determine whether a worker is an employee.
Here are relevant considerations when classifying subcontractors:
- Whether you control the worker’s schedule.
- Whether the worker is using entrepreneurial initiative, judgment or foresight.
- Whether the worker has any investment in facilities, equipment and supplies.
- Whether the worker has opportunities for profit or loss.
- Whether the relationship is permanent or temporary and whether it is indefinite or for a specified duration.
- Whether and to what extent the work is an integral part of your business.
- If you train workers, direct their tasks, set specific hours and dictate how the work should be completed, the IRS is more likely to classify them as employees.
- If workers set their own hours and decide how and when to get the job done, that could mean they’re independent contractors (because only the result of their work is under your control).
- Is the worker paid a salary or regular company wage or a flat fee per job? The government will be inclined to call a worker an independent contractor if they have significant investment in their business — equipment, training and licensing — but aren’t reimbursed for expenses like fuel, tools and office supplies.
The ultimate determination rests on whether all the factors taken together establish that workers are economically dependent on your company for their livelihood, which would make them employees and not contractors. Even if you grant your workers considerable discretion in determining how they do their work, as long as you retain the legal right to control their activities, the workers are employees.
If you’re giving workers 1099s for regular work year after year, that can draw the attention of tax authorities. And then you’ll be liable for back payroll taxes and benefits — even participation in a retirement plan.
Your payroll gets complicated, it’s true. The job may cross state lines, with different states having different rules for drawing the line. If there’s any doubt, you may want to take the conservative approach and classify the worker as an employee.
If a worker is classified as an employee, you need to withhold and pay Social Security and Medicare taxes and pay unemployment taxes on wages paid. If a worker is classified as an independent subcontractor, you aren’t required to do as much legwork. Independent subcontractors arrange and pay for their own income taxes on a quarterly basis, aren’t given any benefits and aren’t eligible for things like unemployment insurance.
Independent subcontractors get paid for projects, worry about their own taxes, and work when and where they want.
As a business owner, you need to file different tax forms depending on whether you’re hiring employees or independent contractors or subcontractors. Remember that misclassifying employees as contractors carries a much higher penalty than misclassifying the other way around. The bottom line? Consult with a financial professional who can help you organize your personnel correctly from day one. Questions? We can help.
© 2021
