The question of whether the people who work for you are employees or independent contractors is always important for business owners: A mistake in this area – typically, categorizing workers as independent contractors when they actually qualify as employees – is one that can result in financial penalties and other issues if you’re incorrect.
Recently, too, it’s come to the forefront in regard to the federal Paycheck Protection Program (PPP) loans. This is because while the PPP funds can be used to pay employees, they can’t be used toward independent-contractor costs.
Additionally, independent contractors are eligible to apply for and receive PPP funding as self-employed individuals. Still, if they subcontract work, they can’t pay their independent contractors with PPP funds. And as business owners consider potentially restructuring business models as part of reopening plans, it’s important to classify workers correctly.
Here, we look at key differences between employees and independent contractors. While this overview will help you understand the differences, we encourage you to review this important issue with your certified public accountant, business attorney or human resources team.
Overview of employer responsibilities for employees and independent contractors
In regard to pay and taxes, when workers are categorized as employees, their employers are responsible for withholding and paying several taxes and applicable insurances for them. When categorized as independent contractors, the workers are responsible for paying for and managing taxes and benefits for themselves.
If you applied for a PPP loan, you may already know who falls into which categories and how that impacts your loan (both the amount you qualified for as well as who can receive payment from these funds). Importantly, as businesses reopen and reconsider their staffing needs, it’s important to be aware of the differences so that you use PPP loan funds correctly, as well as stay on the right side of employment laws.
The Internal Revenue Service (IRS) has extensive online information about this topic and we recommend consulting the IRS website to become familiar with the differences. Be aware, though, that not every employee will meet all criteria, although to be considered an employee, a worker will typically meet many of them. This comparative overview may also help.
Who qualifies as an employee?
The most common type of employees are referred to as “common-law employees.” These are the basic criteria that determine whether a worker qualifies as an employee:
- Behavioral: If the work that’s done and how it’s done is typically dictated by the business, this often denotes that a worker’s responsibilities are controlled by the business.
- Financial: If the business controls key aspects like when a worker is paid and if the business owns and controls the equipment used to accomplish the work, the worker likely meets the “financial” criteria as an employee.
- Type of relationship: Employees are often hired at a certain pay rate (salary or hourly) and are often expected to perform their work during certain hours of business, usually onsite at the place of business. Independent contractors often determine their own pay rates, schedules and workflow.
Who qualifies as an independent contractor?
As stated by the IRS, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
Many small business owners act as independent contractors who offer their services to other businesses or clients and who determine their hours, rates, offerings, work location and other factors. Independent contractors typically collect payment at the time of services or through agreed-upon payment schedules, such as through a monthly invoice to clients. Often, though not always, independent contractors will receive pay from several sources, whereas employees often receive a paycheck from one employer per job held.
Independent contractors are responsible for obtaining their own professional licenses, permits and business insurances and pay their own federal, state and local taxes, as applicable, as well as self-employment taxes. Independent contractors also manage and pay for their own fringe benefits, such as retirement accounts or disability insurance.
Using PPP funds to pay your workers
The pandemic has brought enormous challenges to businesses, financially and otherwise, and for many businesses and their employees, the PPP loans provide a financial lifeline. As you reopen, and particularly as your business model evolves or as you restructure to meet COVID-19 protocols, review your plans with your accountant.
What should you do if you think you’ve incorrectly categorized a worker?
There can be significant financial penalties for businesses that are determined to have miscategorized workers intentionally to avoid paying taxes, required insurances (like disability insurance, if required by the state or industry) and other expenses.
However, it’s widely recognized that this is a confusing area for many business owners and often, it’s simply a mistake. For that reason, the IRS offers ways to rectify the situation, including the Voluntary Classification Settlement Program. Before contacting the IRS, though, consult with tax or labor professionals who can guide you.
Pursuit can help you secure PPP funding
If a PPP loan would benefit your business but you haven’t yet applied, please contact us today. Our online application is easy, quick and straightforward and we’ve helped thousands of small businesses get the funds they need.
Reopening is both challenging and exciting as we move forward together and taking these steps now will ensure that you do so with confidence.