Have you properly classified the people who work for you as an independent contractor vs employee?
Do you even know the difference?
Here's what most business owners do know… When they hire someone on as an independent contractor, they don't have to pay payroll taxes on that individual, nor do they have to pay benefits, unemployment insurance or workers' compensation insurance. You do not need to withhold taxes on the money you pay to an independent contractor either.
Sounds great right? So why wouldn't we just classify everyone as an independent contractor?
Because you can get in big trouble if you mess it up the classification, whether you mean to or not. (And by “big trouble”, I mean significant legal and financial liability when something about the employment relationship goes south or if the IRS decides to audit you.)
So how do you decide whether someone is an employee or an independent contractor? Here's a quick overview of both classifications.
Independent Contractor vs Employee
Here are several factors that you can consider when determining whether someone should be classified as an independent contractor vs employee. The factors fall under three main categories, which include: behavioral control, financial control, and the relationship between the parties.
The main question here is whether the company controls or has the right to control what the worker does and how they do their job. If the answer to that is yes, then the individual is more likely an employee than an independent contractor.
When considering behavioral control, it is helpful to consider the instruction and training provided to the worker. The more instruction given to the individual, and the more instruction provided on how to do a certain job, the less likely it is that they are considered an independent contractor.
The big question when considering financial control is whether or not the business aspects of the worker's job are controlled by the employer. Here are some factors to consider:
- Investment – How much of an investment has the individual made in his or her own business? The larger the investment, the more likely it is that this individual should be considered an independent contractor.
- Unreimbursed Expenses – Does the worker have a large amount of unreimbursed business expenses? If so, they are more likely an independent contractor.
- Services. Does the worker offer the same or similar services to the general public? Are they even allowed to work for anyone other than the employer? If yes, they may be an independent contractor.
- How paid – An employee is typically paid by the month, week, or hour. An independent contractor is typically paid by the job.
- Profit/Loss – An independent contractor has the opportunity to profit from his/her work, but also carries with them the risk of loss.
The final category of factors to consider is the relationship between the parties. Even though the intent of the parties is not determinative of an independent contractor relationship, it is an important factor to consider.
- Intent – What did the parties intend when the employment relationship was formed? Did they enter into a contract that outlines the duties and responsibilities of the parties? Keep in mind that even if the parties intended to create an independent contractor relationship, if the “substance” of the relationship is more in line with employee/employer, then the worker will be considered an employee.
- Benefits – If the employer provides benefits (i.e. health insurance, retirement, etc.) than an employer/employee relationship is likely.
- Termination of the Relationship – Can the employer refuse to pay for unsatisfactory work performed by the worker? Does the employer retain the right to terminate the relationship if it deems necessary?
- Permanency of the Relationship – Is the worker being hired for a specific project or period of time, or is the nature of the work an ongoing or permanent nature?
- Regular Business of the Company – Does the employer have the right to direct and control the services performed? Is the worker performing work in the regular business of the company?
In determining whether there is an employee or an independent contractor relationship, it is important to weigh all of these factors, as any one factor alone is not determinative of the classification.
According to the IRS:
Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
Consequences of Misclassifying Employees as Independent Contractors
In setting up your business and hiring employees, if you improperly classify a worker as an independent contractor, when they should properly be classified as an employee, then the consequences can be severe. This is especially true if you have no reasonable basis for classifying the employee as an independent contractor.
Here is a small sampling of some of the potential legal and financial consequences you could face by misclassifying a worker as an independent contractor:
- You may be held liable for employment taxes for that employee; and/or
- You could be held responsible for damages (including indemnification payments, medical benefits, and statutory and/or criminal penalties) if the employee is injured on the job and you failed to carry workers' compensation insurance as required by law.
How might this affect your Amazon Business?
Once your Amazon business gets large enough, you most likely will want to hire either in-house or virtual staff to assist you with such things as customer service, responding to customer feedback, dealing with suppliers and shipments, building a website, social media marketing, etc. How you classify your staff is important, and can have dire consequences if done improperly.
At Hawthorn Law, we work with Amazon Sellers to make sure all their legal ducks are in a row. We will help you to draft independent contractor agreements to keep you from getting in the crosshairs of the IRS, or work with you to renegotiate your existing contracts. If you would like to schedule a free strategy session to address these issues, please fill out our online form here.