Employee or contractor? How to tell if you've been misclassified.

Classifying a worker as a contractor, rather than an employee, can be great for businesses, but costly for workers. Here's how to prevent misclassification, as well as the financial burden that can come with it. 

Ted S. Warren/AP/File
Katie Baranyuk gets out of a car driven by Dara Jenkins, a driver for the ride-sharing service Lyft, after getting a ride to downtown Seattle.

It has become very common, especially among startups, for businesses to classify some workers as independent contractors rather than employees. Doing so can save companies a significant amount of money in payroll taxes. This may be great for business, but it can be costly for workers — because the full burden of those taxes then falls on them.

Employers and employees normally split the cost of Social Security and Medicare taxes. Workers pay 7.65% of their income, and employers kick in a matching 7.65%, for a total of 15.3% per employee. If you find yourself classified as an independent contractor rather than an employee, you have to pay both halves of the tax yourself, because contractors are considered self-employed. This 15.3% is referred to as self-employment tax, and it’s on top of the income taxes you must pay at your ordinary income tax rate.

Many people who are really employees get classified as independent contractors and end up shouldering more of the payroll tax burden, in addition to being denied any benefits and legal protections that employees are entitled to. To protect yourself from misclassification, it’s important to understand how workers are classified.

What is an employee?

The IRS doesn’t have a universal definition of what makes someone an employee rather than an independent contractor. It depends on the individual circumstances of your work arrangement, but factors that could lead the IRS to consider you an employee include:

  • You work under someone’s direction.
  • You’re paid by the hour or by the piece.
  • You work at your employer’s location.
  • You have your own desk or workstation at the employer’s location.
  • You have set hours.
  • You use your employer’s tools, equipment or computers.
  • You meet with clients under the guise of your employer.

This is not an exhaustive list, but it includes most of the issues the IRS asks about regarding employment status.

If you are truly an independent contractor, the following would typically apply:

  • You would be able to set your own hours.
  • You would not work under someone’s direction. (Someone could give you guidance but could not direct you to work in a specific manner.)
  • You could work from your own location.
  • You would have your own tools, equipment or computer.
  • You would be able to take on other clients or customers and do the same work for them.

What to do if you are misclassified

If you are misclassified as an independent contractor, there are some steps you can take at tax time to remedy the situation.

When filing your tax return, you can list the amount that was paid to you by your employer as wages, instead of putting it on Schedule C as self-employment income. This means you would be responsible for paying half of the Social Security and Medicare tax (7.65% of income, rather than the 15.3% required of self-employed taxpayers), plus income tax.

You would also need to file Form SS-8 with the IRS. This form asks the IRS to determine whether you are an employee or a contractor. It includes several pages of questions about your work arrangement.

There is one important consideration if you decide to use this strategy and you are still working for the employer (or you’re worried about burning bridges): You can’t do it in secret. When you file the SS-8, the IRS will initiate a formal employment tax investigation against your employer. If all workers are being improperly treated as independent contractors, the company could owe tens of thousands of dollars, or more, in employment taxes. This could upset your employer and cost you your job. So make sure you are comfortable with the implications before using this strategy to reduce your tax burden.

Learn more about Craig on NerdWallet’s Ask an Advisor.

This article also appears on Nasdaq

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.

QR Code to Employee or contractor? How to tell if you've been misclassified.
Read this article in
QR Code to Subscription page
Start your subscription today