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Workers Compensation Insurance and taxes: Independent Contractor (1099) or Employee?

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Business owners can hire people as employees or pay them as independent contractors. Getting that distinction right can save you taxes, protect you during insurance audits, keep you out of trouble with your state’s Department or Labor, and help you survive an IRS audit.  Getting it wrong can take you into a nightmare.  

As a business owner or hiring manager, here are seven points to keep in mind when you classify people as independent contractors or employees:

1. Getting it wrong, even unintentionally misclassifying people, can draw penalties and additional taxes due, state labor law penalties.  You can also be audited by your Workers Compensation Insurance company, with additional insurance premium going back three years.

2. Take a look at how the Internal Revenue Service  decides whether a worker is an employee or contractor.  They look at the relationship between a worker and a business. The IRS starts with three factors in determining this relationship:

  a) Type of relationship, which means how both your business and the worker view the relationship.

  b) Financial control; how do you pay the worker? Do you pay by the hour, do you pay by a task or project, do they work for any other company, do you pay the worker directly or do you pay another company for their time?  For Workers Compensation Insurance, the insurance company is going to look at whether you can prove that the worker has Workers Compensation coverage somewhere else.

  c)  Behavioral control; do you set hours, each task, provide tools and computers, starting times, hours worked on a project, provide training?  These and other control questions will be used to decide whether you owe employment taxes and withholding.

3.  Did the worker bid for the job or fill out an application?  Do you have a contract with the worker?  Does the contract refer to a single project or is it open-ended? 

4. Remember that calling someone an independent contractor does not make them an independent contractor, even if they agree with you.  If you direct and control their exact hours, methods, provide the only workplace and equipment they use, you should plan on having to pay them as employees, file tax forms, and withhold taxes as required by law.   Either the business or a worker can ask the IRS to determine whether the relationship is independent contractor or employee.  Take a look at IRS Form SS8 to see what you might have to provide to prove your point. 

5, A worker is likely be classified as an independent contractor if the business directs or controls only the result of the work, not the manner, means, or methods being used to accomplish the end result.

6. Make sure that workers are aware of their classification. This will help them plan for their tax obligations.  Keep in mind that you are trying to avoid the situation where they call the IRS and state Department of Labor to try to claim employment status.   Many workers are happy to be independent contractors until they have a tax problem, or get hurt.

7. You can use the IRS forms, or your state Department of Labor, a labor attorney or, for the Workers Compensation issues, your insurance advisor, to gather information to make a decision on how to classify a worker.  

Here’s the NJ Department of Labor FAQ page which can give you an idea of how they handle classification and eligibility for Workers Compensation benefits.  Give us a call at 973-426-1500 if you’d like advice about New Jersey issues. 

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