independent contractor or employee classificationPublic relations agencies and corporate PR departments frequently hire freelancers and remote workers for both temporary and ongoing work. They frequently classify them as independent contractors and send them 1099 forms for tax reporting.

The benefits of working with independent contractors rather than full-time employees are clear and often irresistible. Businesses don’t pay the contractors benefits or overtime. They avoid the costs and paperwork headache of payroll taxes, including Social Security, Medicare, or unemployment insurance, and workers compensation. They don’t have to provide equipment or office space. But are those contractors really full-time employees who should receive W-2 forms?

Many businesses – probably including PR firms – misclassify employees as contractors in order to save costs. Workers are not independent contractors just because their contract says they are. The IRS considers their relationship with the employer and the employer’s degree of control over them.

Business that misclassify workers risk severe penalties, including back taxes and penalties for those missed payments that can add up to sizable sums. Intentional violations can lead to criminal penalties. There’s also the risk damaged to the corporate reputation.

“Businesses that misclassify employees as independent contractors have a bullseye on their backs,” writes Julie Tappero, founder of the staffing service, West Sound Workforce. Employers can be exposed if a worker files a complaint or files an unemployment claim or a worker’s compensation claim. State and federal agencies perform regular audits to snare offenders.

What the IRS Examines

To determine if people working for you are employees or independent contractor, the IRS considers:

Behavioral control. The worker is an employee if the company controls or has the right to control what the worker does and how the worker performs the job. The company generally provides instructions on how to do the work, gives tools or equipment to use, decides where to buy supplies, and controls other factors.

Important note: Even if the company gives little or no instructions, the IRS can classify the worker as an employee if it retains the right to give instructions.

Training by the business and evaluations of how well the work is completed are other signs that workers are employees.

Financial control. Independent contractors often have a significant investment in their work equipment. They’re more likely to have unreimbursed expenses and have a greater opportunity to make a profit or sustain a loss.

Employees generally receive a guaranteed regular wage for a specific time period, sometimes supplemented by a commission. Contractors typically receive a flat project fee.

Type of relationship. Employee benefits, such as pension plans, insurance, sick pay and vacation pay, indicate that workers are likely employees.

The IRS considers work arrangements that are expected to continue indefinitely, rather than for a specific project or period, as evidence that the worker is an employee.

If workers provide services that are key aspects of the business, the business is more likely to direct their activities, indicating that the worker is an employee.

Determining if workers are employees or contractors requires weighing all these factors. Some IRS guidance is not definitive, and situations vary by industry. For instance, construction workers spend thousands of dollars on tools and equipment and are still considered employees. Law firms often pay independent contractors hourly.  Getting advice from a human resources consultant or employment attorney is often a worthwhile investment to avoid the wrath of the IRS or state agency.

Bottom Line: PR agencies and corporate PR departments face substantial penalties if they misclassify employees as independent contractors. The difficulty is that differences between employees and contracts can be unclear. Determining workers’ status for tax reporting purposes requires considering several factors.