The difference between employees and independent contractors.

• Author: Auerbach, Arthur

The correct classification of workers as either employees or independent contractors is important because it affects not only how workers are paid but also how the government gets paid. Lately, worker classification has become a prominent issue due to the changing economic environment, technological revolutions, and recent legislative and administrative actions. The classification of workers can also affect the calculations of the Sec. 199A qualified business income (QBI) deduction, the amount of Paycheck Protection Program (PPP) loans, the amount of PPP loans that are forgiven, and the calculation of various employment credits (retention, family leave, and sick pay).

What is the difference and why does it matter?

In Publication 15-A, Employer's Supplemental Tax Guide, the IRS identified three categories of evidencethat are relevant in determining whether a worker is an employee or an independent contractor:

* Behavioral control: Whether the business has a right to direct and control how the worker does the task for which the worker is hired;

* Financial control: Whether the business has a right to control the business aspects of the worker's job; and

* Type of relationship of the parties: Facts that show the parties' type of relationship (e.g., the degree of permanency, whether employee-type benefits are provided).

Why does this matter? In a nutshell, workers who are employees receive a Form W-2, Wage and Tax Statement, and employers must withhold taxes from employee paychecks and remit them to the IRS on the employee's behalf. And not only income taxes are withheld: Employers must also withhold Social Security and Medicare taxes (together known as Federal Insurance Contributions Act (FICA) taxes). The FICA tax is 15.3%, of which the employer and employee each pay 7.65%. Then, there are the Federal Unemployment Tax Act (FUTA) taxes and state unemployment tax act (SUTA) taxes. In most states, only the employer pays unemployment taxes; they are not deducted from the employee's wages. The FUTA tax rate is 6%, but it is offset in large part by credits for SUTA payments.

It is easy to understand why businesses, from a financial perspective, might prefer having workers classified as independent contractors: The business would not have to withhold income tax and would not be liable for 50% of the FICA taxes and 100% of FUTA taxes for the worker. The reduction in benefit expenses is also substantial.

In addition, this determination affects the...