Article courtesy of Payne Financial Benefits Bulletin newsletter, January 2012 issue.

Employee or independent contractor? The answer has serious implications on your tax and benefit obligations, and you are also liable for significant financial penalties if you misclassify your workers.

Classifying a worker as an independent contractor is often financially advantageous for a company, as the company is not responsible for paying various payroll taxes or providing benefits. However, the risk of misclassifying a worker is significant, so it is important that companies exercise due diligence in ensuring proper worker classification.

Because it can be difficult to differentiate between employee and independent contractor, the IRS created three criteria to help employers make the distinction:

• - Behavioral control: If the company trains the employee, specifies the hours of work, tools to be used, specific tasks to be performed, and how the worker goes about the job, the worker is likely an employee.
• - Financial control: If the worker is paid a salary and restricted from working for others, he or she is likely an employee.
• - Relationship: This may include whether a contract exists between the worker and company, and whether the worker gets benefits and specified time off. A contract typically suggests an independent contractor, while benefits and time off are generally given only to employees.

Beyond employee and independent contractor, there are two more classifications:

• - Statutory employee: Workers classified as an employee for certain tax purposes, including certain distribution and delivery drivers, full-time life insurance or annuity agents, individuals who work at home using your materials and specifications, and full-time traveling salespeople.
• - Statutory non-employee: Workers treated as self-employed for federal tax purposes, generally including direct sellers and real estate agents.

If employers are unsure about the classification of a worker, they can file a Form SS-8 with the IRS, and the IRS will determine the worker's status: www.irs.gov/pub/irs-pdf/fss8.pdf.

In addition, the IRS recently announced a new Voluntary Classification Settlement Program. The program gives employers the opportunity to reclassify workers who may have been misclassified in the past, rather than risk an IRS audit. Employers would be subject to a minimal payment covering past payroll tax obligations, avoiding much higher fees and penalties in the event of an audit. More information can be found here: www.irs.gov/newsroom/article/0,,id=246203,00.html.