As a Pennsylvania business attorney, I see many businesses make the same mistakes. Misclassification of employees as “independent contractors” is a mistake many businesses make that exposes them to serious risk. In general, a business owner must withhold income taxes, withhold and pay Social Security and Medicare taxes and pay unemployment on wages paid to an employee. A business owner does not generally have to withhold or pay any taxes on payments to independent contractors. Federal and state authorities make the distinction between an employee and an independent contractor based on whether sufficient control is present to constitute an employer-employee relationship. Control is composed of three primary characteristics: behavioral control, financial control and type of relationship. The Internal Revenue Service has a “20 Factor Test” to help make this determination. The relative degree of importance for each factor can vary considerably depending upon the occupation and the factual context of each particular situation. Some of the key considerations included in the 20 Factor Test are as follows:
- Continuing Relationship
- Set Hours of Work
- Employer’s Premises
- Payment by Hour, Week, Month
- How integral are the services provided by the individual to the employer’s business?
- How permanent is the relationship between the individual and the employer?
- What amount has the individual invested in facilities and equipment to perform his or her services?
- How much initiative and oversight are required for the individual to be successful?