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Worker Classification Guide

Factory Workers

Anyone you hire to do work for your business is either an employee or an independent contractor. The difference matters when it comes to things like unemployment insurance, the minimum wage, overtime payments, taxes, and workers' compensation.

For each of your employees, you must withhold income tax, social security tax, unemployment tax, and Medicare tax. But you do not have to withhold taxes on payments you make to your independent contractors. Independent contractors are self-employed and handle their income tax and self-employment taxes independently.

It can sometimes seem like there is a fine line between employees and independent contractors. But this guide can help you determine how to classify your employees.

Independent Contractors vs. Employees

Independent contractors are often self-employed business owners. They generally work how and when they choose. They sell their services to many businesses. Workers who perform tasks their own way, on their own time, with their own equipment, are more likely to be independent contractors.

An employee performs tasks when and how their employer tells them to. The more control you have over a worker, the more likely that the worker is your employee.

There is not a specified set of requirements that creates an employee relationship. Instead, you must weigh the specific facts of your business situation. Depending on the situation, some factors might carry more weight than others.

To help determine whether your workers are employees or independent contractors, go through the following questions. Every “yes" to one of the below questions inches you closer to an employee relationship. Every “no" is a factor pointing toward an independent contractor relationship.

Do You Control How Your Workers Do Their Jobs?

If you manage the way workers perform tasks, they are more likely to be considered employees. If the following factors apply to you, you probably control how your workers do their jobs:

  • You decide where and when the workers perform their tasks.
  • You tell workers where to buy materials.
  • You decide which supplies your workers use.
  • You tell workers which tools to use.

When business owners hire independent contractors, they control the outcome of the task. But the business does not control the method, materials, or hours of the work. The more control you have over how your workers do their jobs, the likelier they are to be employees.

Does Your Working Relationship Continue Indefinitely?

If you have not established an end date to your working relationship, then it is more likely that a worker will be considered an employee. Independent contractors usually perform tasks for a limited period of time.

If your workers are time-limited independent contractors, it is a good idea to say so in a contract. But you cannot establish an independent contractor relationship with a contract alone. If other factors point toward an employee relationship, they might still be considered an employee.

Do You Have Financial Control Over Your Workers?

The more financial control you have over your workers, the likelier it is that they are employees. Independent contractors usually pay for supplies themselves. They also do not get reimbursed for working expenses and have many clients.

To answer this question, consider the following issues:

  • Do your workers work for other businesses? Independent contractors usually sell their services to several companies.
  • Are you your workers' only source of income?
  • Do you pay your workers a flat rate for tasks completed? Independent contractors usually get a flat rate for a job rather than a salary or an hourly rate.
  • Can your workers earn a profit or incur a loss on the work? Independent contractors are more likely to control the financial and business aspects of their own work.
  • Do you give paid time off, a base salary, or benefits? If you offer these types of employment perks, your workers are more likely to be employees.

Are the Workers' Services a Key to Your Business?

Does your business rely on your workers' services to maintain a core feature of your business? If so, this points toward an employee relationship. An example might be an accounting firm that hires accountants. The accountants at the firm provide the main service of the business. Their employer probably also controls how they do their jobs. Both factors would point toward an employee relationship.

Getting a Determination About Worker Classification

If you are still uncertain about classifying your workers after going through the above questions, you might want to ask the IRS to make a determination for you. You can use IRS Form SS-8 to do just that. After you submit the form, the IRS will tell you your worker's status for federal employment tax purposes.

The IRS may take several months to reach a determination. Even if it takes some time, though, it's essential to reach a correct conclusion on worker classification. There can be hefty fines and back taxes to pay for misclassified employees.

When employers misclassify workers as independent contractors, it can reduce the businesses' tax payments. So, governmental bodies are motivated to correct employee misclassification to ensure companies are paying their fair share. You may also want to consult with an area business attorney if you have questions about your workers' status.

If you already misclassified workers as independent contractors, the IRS may still let you off the hook on some of the fines and back taxes. To get this relief, you must show that:

  1. You had a reasonable basis for misclassifying your workers as independent contractors.
  2. You classified similar workers as independent contractors too.
  3. You have filed your taxes and informational returns on time. Informational returns include Form 1099-MISC for payments to independent contractors.

Overtime Pay and Minimum Wage

The Fair Labor Standards Act (FLSA) is federal law that sets federal wage and overtime standards for most employees. True independent contractors are not entitled to minimum wage or overtime under the FLSA. But if your workers are employees, then you must follow minimum wage and overtime laws.

Under the FLSA, employers must pay a minimum wage of $7.25 per hour. But many states have minimum wage requirements that are higher than the federal minimum. The U.S. Department of Labor provides an interactive map to help you find your state's minimum wage.

Overtime occurs when employees clock more than 40 hours of work in a standard seven-day work week. If you do not want your workers to clock overtime hours, it's a good idea to create an overtime policy. Your policy should state that a manager needs to pre-approve any overtime hours.

If your workers truly qualify as independent contractors, they are not entitled to overtime or minimum wage under federal law. Employees, however, must get at least minimum wage. They must also receive overtime pay unless they fall under an exemption. You should also check your state laws or talk to an attorney before you decline overtime payments or pay under the minimum wage.

Are Your Workers Exempt From Overtime Requirements?

Some employees are not covered by the FLSA. If your employees qualify for an exemption from the FLSA, they are not entitled to overtime compensation. Certain types of employees are exempt from the FLSA by definition. Some commonly exempted jobs include:

  • Farmworkers
  • Employees at seasonal businesses or recreational facilities
  • Sales people who earn most of their wage through commission
  • Certain computer professionals paid at least $27.63 per hour

For more details on these exemptions, talk to your local Department of Labor Office. There are also other, less common, exemptions listed on the Department of Labor's website.

Executive, Professional, and Administrative Exemptions

Even if your employees are not working the types of jobs described above, they may still be exempt from federal overtime rules. Workers who perform executive, professional, or administrative job duties can also be exempt.

Executive Exemption: To qualify for the executive exemption from the FLSA, your employee must:

  1. Earn at least $684 per week.
  2. Supervise two or more full-time workers.
  3. Manage the business or a part of the business as their main job duty.
  4. Have hiring and firing authority or input.

Professional Exemption: The professional exemption usually applies to highly educated employees. Examples include doctors, nurses, architects, lawyers, and others whose jobs require specialized education. This exemption will apply if an employee earns at least $684 per week and:

  1. They have a specialized education, such as a postgraduate degree.
  2. Their main job duties require them to use their specialized education.
  3. The work is considered intellectual and requires professional judgment.

Administrative Exemption: The administrative exemption requires that the employee earns at least $684 per week. This exemption also requires that:

  1. The employee's work must be nonmanual or office-based.
  2. Their work should relate to the operations of the employer's business.
  3. The employee must use their own discretion and judgment on significant issues.

If your employees do not qualify for an exemption under the FLSA, then you must pay them at least minimum wage. You must also pay them overtime wages for each hour they work above a 40-hour workweek. The wage for overtime should be one and one-half of their normal hourly wage.

How an Attorney Can Help

You could face fines and back taxes if you misclassify employees as independent contractors. But correct classification could save your business from those penalties and legal hassles. If you have any remaining doubts on how to classify your workers, a local business attorney can help.

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