Stead & Associates

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Should you classify a worker as an Employee or Contractor

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While the differences between an employee and an independent contractor may seem minimal, the effects of mislabeling your employees as independent contractors can have drastic results. Therefore, the contrasts between them are important to know for any successful business owner.

An employee in the state of Arizona is anyone who performs a service for you and you control what will be done and how it will be done.[1] Employees can still have freedom of action but the employer has the right to control how the services are conducted. For example, you want your secretary to file a document for you. Your business will likely have a process of how that document is labeled and where it is located for future use.

Independent contractors, by contrast, are typically involved in an independent trade. [2] Independent contractors perform services for those who have the right to control or direct only the result of the work done and are not able to dictate the means or methods of how the worker(s) accomplish the result. [3] An example of this is when you hire a builder for your home. While you may have control over the result of the project (your home), you do not have control over the details of how the builder produces the home.

In Arizona, the distinction between employees and independent contractors is determined using the “right of control” test described above. This test considers whether the employer can supervise or control the processes used in obtaining the result desired or if they simply control the result reached, but the worked controls the method used in reaching it. [4]   

The courts often determine who has the right of control between parties by looking at the circumstances of the relationship or hiring arrangement. Judges consider various factors when determining whether a claimant is an independent contractor or employee.[5] These factors include:

  • the duration of the employment
  • the method of payment
  • who furnishes equipment
  • who has the right to fire and hire
  • who bears responsibility for workmen’s compensation insurance
  • the extent of the employer’s control over the details of the work

These factors are considered together in totality rather than individually so there is not one factor that is more significant than the others.[6] The IRS has a supplemental guide for employer’s who have further questions above whether their workers are employees or independent contractors.[7] However, the best way to be sure that your payroll is being handled correctly is to consult a professional. These worker distinctions may seem minimal, but they are very important when it comes to protecting your business from liability.

Businesses with employees are responsible for paying, collecting, and remitting federal and state payroll taxes, providing workers’ compensation insurance, and other benefits.[8] An employer who is responsible for providing these benefits, but fails to do so, may be held liable for both the employer’s and the employee’s portions of Social Security, Medicare, or federal income taxes. A business may be liable for employment back taxes if it is determined by the courts that an individual was misclassified as an independent contractor. The IRS also imposes criminal penalties and fees for those who misclassify individuals working under them.[9]

Businesses who misclassify their workers are often discovered when a worker who has been previously identified as an independent contractor files for unemployment benefits or is injured on the job and applies for workers’ compensation. Independent contractors can also file a complaint with either the state Department of Labor or the U.S. Department of Labor. Both the Department of Labor and the IRS have focused audits in the past on misclassified independent contractors.[10] Even if a misclassification is unintentional, an employer cans till face penalties. Also, intentional fraud or misconduct can result in further fines and penalties.

Understanding the distinction between employees and independent contractors is not only beneficial in reducing liability for your business, but it also creates security for those who work for you.

Citations

[1] https://www.irs.gov/businesses/small-businesses-self-employed/employee-common-law-employee

[2] https://des.az.gov/services/employment/unemployment-employer/employer-handbook-unemployment-insurance-tax/employment

[3] https://www.azcommerce.com/small-business/checklist-items/having-employees-and-job-training-programs/independent-contractors/#:~:text=The%20general%20rule%20is%20that,methods%20of%20accomplishing%20the%20result.&text=Independent%20Contractor%20(Self%2DEmployed)%20or%20Employee%3F

[4] https://1.next.westlaw.com/Document/I77ec39ccef2e11e28578f7ccc38dcbee/View/FullText.html?navigationPath=Search%2Fv1%2Fresults%2Fnavigation%2Fi0ad604ac00000186041455bcaffa8ebb%3Fppcid%3De76b73d4b00346d2b424333b66a51a5f%26Nav%3DKNOWHOW%26fragmentIdentifier%3DI77ec39ccef2e11e28578f7ccc38dcbee%26parentRank%3D0%26startIndex%3D1%26contextData%3D%2528sc.Search%2529%26transitionType%3DSearchItem&listSource=Search&listPageSource=3bd57a1a0795fc581cddebf105f7aa1a&list=KNOWHOW&rank=2&sessionScopeId=96064cfc845c5845c3aa45c2de94dd0e9481ed78f528aea02db61f117ea4a98a&ppcid=e76b73d4b00346d2b424333b66a51a5f&originationContext=Search%20Result&transitionType=SearchItem&contextData=%28sc.Search%29

[5] Home Ins. Co. v. Indus. Comm’n, 123 Ariz. 348, 350, 599 P.2d 801, 803 (1979).

[6] Munoz v. Indus. Comm’n of Arizona, 234 Ariz. 145, 150, 318 P.3d 439, 444 (Ct. App. 2014) shorturl.at/pDHOW

[7] https://www.irs.gov/pub/irs-pdf/p15a.pdf

[8] https://gao.az.gov/sites/default/files/9050%20Employee%20vs.%20Independent%20Contractor%20180827.pdf

[9] https://www.justworks.com/blog/consequences-misclassifying-workers-independent-contractors

[10] https://www.justworks.com/blog/consequences-misclassifying-workers-independent-contractors

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