J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Worker Classification

In order to know whether payments to workers are wages, you must first determine whether the workers are employees or independent contractors. This is a hot issue for the IRS because there are substantial tax dollars at stake. The issue, however, goes beyond the IRS and concerns the Department of Labor (because wage and hour laws apply to employees but not to independent contractors) and the National Labor Relations Board (because only employees can be unionized). State labor departments are also concerned with correct worker classification because only employees can claim unemployment benefits and workers’ compensation.

A worker is treated as an employee if your company exercises sufficient control over when, where, and how the work gets done. If you control only the final results, the worker may be an independent contractor. The IRS agents are provided with a special audit manual designed to help the agents reclassify a worker as an employee if appropriate (view this manual at www.irs.gov/pub/irs-utl/emporind.pdf). The key to worker classification is control. In order to prove independent contractor status, you, as the employee, must show that you do not have the right to control the details and means by which the work is to be accomplished. You may also want to show that the worker has an economic stake in the work (that the worker stands to make a profit or loss depending on how the work turns out). It is helpful in this regard for the worker to supply ...