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Are You Classifying Your Employees Correctly?

Classifying your workforce can be difficult. Misclassification of employees and independent contractors is a common mistake made by many nonprofit organizations. This misclassification can end up costing the organization a significant amount of money in IRS penalties, state penalties and back taxes.

So how do you make the distinction? Like most situations in today’s world, nothing seems to be black and white. Digging into whether your worker is an independent contractor or employee can be tricky. Here are a few guidelines to help you make the distinction:

  1. Who has control over the work performed? If the organization can control and direct the way in which the work is performed, the worker would likely be considered an employee. If less instruction and training is given, the worker may be an independent contractor.
  2. Is there a position description? Usually job descriptions are only created for employees. Independent contractors sign a contract and within that contract is a description of the scope of the work to be performed.
  3. Who has financial control? In other words, who has the opportunity for profit or loss? If the organization does, the individual would likely be an employee. If the individual can realize the profit or loss, this is a good indication they are an independent contractor. Reimbursement of expenses is another good indication. If the individual is liable for all or most of the expenses, they are likely an independent contractor.
  4. Are benefits received? If a worker receives benefits, such as insurance or paid leave, that is a good indication they are an employee.

Once a determination has been made on whether an individual is an employee or an independent contractor, be sure you are following all filing and withholding requirements. For any employees, you should be withholding federal taxes, as well as state and local, if applicable. If you are working with an independent contractor and you have paid them more than $600 in the calendar year, you need to file Form 1099-MISC and report their income. You should also remind them they are personally responsible for all income taxes and insurance coverage.

As stated above, this distinction can be very difficult to make and this is an area the IRS has been recently scrutinizing so it is important you are classifying your workforce appropriately. Contact your GBQ advisor with any questions.

Article written by:
Alicia Hammersmith, CPA
Tax Senior

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  • Senior Director, Assurance & Business Advisory Services
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  • Director, Assurance & Business Advisory Services
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