One of my jobs as a finance & operations (F&O) consultant is to worry. For example, I generally notice some peculiar payment practices for staff members at every business I start servicing, which are based on what the owner thinks rather than what they know to be true. That’s when the worrying begins until I can pull in a third-party expert to assuage my fears.
My first client in the early 2000s was one of the large professional food contractors in Missouri. During big catering events, they paid their casual labor in cash (that’s right – in currency, not by check). The bookkeeper recorded the cost as independent contractors because that’s how casual labor is recorded in this industry. By the way, casual labor refers to part-time help for a few hours at a food event, and this help is currently not on the payroll.
And that reminds me of another practice I occasionally observe. College summer and Christmas interns are being classified as independent contractors. I am 99% certain that is a no-no. My best advice is always to seek out a payroll expert and/or a labor attorney. They will know the answer.
What is an Independent Contractor?
I will refrain from using AI or a Google search to answer this question. In short, an independent contractor:
- owns a business (that is, they have other clients/customers)
- controls the work, not the person paying them
- generally (nearly always) provides their tools and technology to perform the work
My interpretation of IRS classification of labor is that it’s defined not by the Internal Revenue Code, but by case precedents from past court rulings. However, my three incomplete guidelines above will help to determine if the contractor should be classified as an employee if they clear those hurdles.
Don’t Misclassify Just to Avoid Payroll Tax Dollars
Although I’m not a tax practitioner, I try to complete a few tax CPEs every two or three years. I once heard Bob Jennings talking about the penalties of misclassifying workers. The penalties include the misreporting of prior 941s dating back to when these payment errors were made to supposed contractors. If that’s still true, those penalties will far exceed the cost that would have been incurred had the employer paid these workers as W-2 employees.
In short, don’t try to save a few dollars by classifying an employee as an independent contractor. If you are in doubt, as I mentioned earlier, consult with a payroll expert or labor attorney.
Help! I’m Not in Compliance, What Do I Do?
I’m assuming you’ve asked for input on employee/contractor classification. If they say you should be paying contractors as employees, that’s where your CPA can help.
I’m sure larger firms have had to make these fixes in the past. I’m also confident they can serve as the bridge between you and the IRS to resolve past discrepancies. You may wind up paying some fees and penalties, but potentially substantially less by coming clean and getting this practice right in your back office.
Also, don’t worry about compliance overwhelm. I cover that in the article below.
