What Construction Contractors Need to Know to Avoid Costly Mistakes
Doug C. Miller - Herbein + Company, Inc.
Construction contractors often use independent contractors as a way to reduce costs. Therefore, the use of independent contractors may seem like an obvious alternative to hiring an employee. However, construction contractors need to be cautious to first determine if the worker they engage actually qualifies as an independent contractor. Incorrectly classifying a worker can be very costly.
Note that while this article focuses on construction contractors, it is applicable to all employers.
Determining if Your Worker is an Independent Contractor
Generally, you must consider a combination of three key factors to determine if the worker qualifies as an independent contractor. The IRS has identified three groups of key factors as follows:
- Does the employer have the right to control what, when, and how the worker does his or her job?
- Does the employer provide training to the worker?
- Does the worker get paid an hourly wage or a salary? (versus a flat fee or on a time and materials basis)
- Does the worker get reimbursed for business expenses?
- Does the worker not have opportunity to profit or lose money from the work they perform?
- Does the employer provide the tools or equipment necessary for the worker to perform his or her job?
Type of Relationship
- Does the employer provide benefits such as insurance, vacation or sick pay, or a retirement plan?
- Does the worker work solely for one employer?
If you answered “No” to most of these questions, then most likely your worker could be classified as an independent contractor. If the worker is an independent contractor you would not have to pay payroll taxes for that worker. Also, rather than filing a Form W-2 for the worker, Form 1099-MISC should be filed with the IRS and your state for all independent contractors paid $600 or more in one year.
Dangers of Incorrect Classification
Classifying a worker as an independent contractor can be very beneficial and cost efficient. However, If an employer incorrectly classifies a worker as an independent contractor, the employer can be liable for:
- Employer’s share of all employment taxes, including federal and state withholdings that would have been paid if the worker had been classified as an employee
- 20% of the employee’s share of Social Security and Medicare taxes
- Penalties for violations of minimum wage and Fair Labor Standards Act reporting requirements
- Penalties for failure to provide retirement or health benefits
- Back wages or overtime due to the employee
- Workers’ compensation benefits
What to Do if You Misclassified a Worker
If you believe that you may have misclassified an employee as an independent contractor, the IRS has a Voluntary Classification Settlement Program (VCSP) for which eligible employers can gain partial relief from federal unemployment taxes. For additional information on this program visit http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Voluntary-Classification-Settlement-Program.
Virtually all construction contractors use independent contractors. Determining whether they are appropriately classified as such is vital to avoiding significant tax costs and penalties.
Please contact our office or the author Doug C. Miller at [email protected] if you have questions regarding the determination of whether your workers are independent contractors or employees.