Misclassifying Workers Can Lead To Costly Penalties

Avoiding payroll taxes by intentionally or unintentionally misclassifying employees as independent contractors is a costly mistake.

Most often the misclassification will be discovered during an audit or if a former worker files a complaint. Under “the twenty factor test” in Revenue Ruling 87-41, an employee is anyone who performs services for an employer if the employer can control what will be done and how it will be done. However, in an independent contractor relationship the employer has the right to control or direct only the result of the work done, and not the means and methods of a accomplishing the result.

How to properly create an independent contractor relationship

Foremost, you must have an independent contractor agreement in place. This will help define the responsibilities of the independent contractor to follow proper standards under the law. Next, the independent contractor should set up his own corporation or LLC. Then the  independent contractor relationship is between two entities. This helps the employer prove he is not controlling methods to accomplish the result.

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