Understanding the Definition of Employee
Most people think they understand the definition of employee instinctively – until they happen to start a business of their own! Employees and contractors are defined very clearly by the IRS for tax purposes and businesses must understand how these two categories of workers are differentiated.
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Many business owners try to pass off employees as contractors to save on taxes and other payments. However, in a small business set-up there are several grey areas and you may inadvertently classy an employee as a contractor. If IRS discovers this and determines that the classification was willful, you will have to pay all the taxes, penalties and interest. So understand the definition of employee well and figure out how to classify contractors.
The IRS relies largely on common law rules for the definition of employee and to differentiate between employees and contractors. And you know what? You must do exactly the same! After all, it is the IRS that you’re trying to protect yourself from. Using the common law, you must assess if an individual you have hired fits into the definition of employee or would be better slotted as a contractor. Remember, you do save a lot on taxes, medical care and social security when you hire a contractor, so don’t hesitate to get that contract drawn up if under common law, the individual can be classified as a contractor.
Degree of control is crucial under common law to assess the nature of the employee-employer relationship. This includes the professional relationship of the individuals, behavioral control and financial control.
Meaning of control
Each of the three different ‘control’ areas are clearly defined in common law. Behavioral control defines how and how much control you have over how the employee works. The greater the behavioral control, the higher the chances that your relationship is that of an employee and employer. After all, telling people they can’t be late, must do their job well, must ‘submit the report first thing on Monday morning’ is the definition of employee and employer relationship! Financial control covers the areas related to business expenses, including how the individual is paid and if the individual incurs profits and losses independent of his or her work with you. The definition of employee also depends on the professional relationship of the parties. This can be assessed by a written contract, the length of the relationship and other factors.