Independent Contractor or Employee? Distinction is Important to Avoid IRS Woes for Charter Schools
A worker cannot be both an employee and an independent contractor at the same entity per the Internal Revenue Service (IRS) and mistakenly classifying an employee as an independent contractor can result in significant fines and penalties.
Regardless of the fact that certain job duties are not part of a regular employment contract with the school, they still need to be paid through payroll. Coaches and referees are two examples of commonly misclassified individuals.
The determination is made on the relationship with the worker, not each type of work the worker is doing. A charter school has a continuing relationship with an employee, while the school’s relationship with an independent contractor is limited to a specific time frame.
Under common-law rules, anyone who performs services for the school is an employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that the school has the right to control the details of how the services are performed.
A school must show there is a reasonable basis to classify the worker as an independent contractor in order to escape the burden of paying taxes for the worker. If the school already classifies the worker as an employee, you will have a tough time making a case with an IRS. Misclassifying the worker can expose the school to additional risk and back taxes. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker and late payment penalties.
The courts have considered many facts in deciding whether a worker is an independent contractor or an employee. These relevant facts fall into three main categories: behavioral control; financial control; and relationship of the parties. So, how does your school determine the correct classification? Below are some definitions an examples to help you sort it out:
A worker is an employee when the school has the right to direct and control the worker. The charter school does not have to actually direct or control the way the work is done – as long as the school has the right to direct and control the work.
- how, when, or where to do the work
- what tools or equipment to use
- what assistance to hire to help with the work
- where to purchase supplies and services
If the school provides the worker with training about required procedures and methods, this indicates that the school wants the work done in a certain way, and this suggests that the worker may be an employee.
If the worker receive benefits, such as insurance, pension, or paid leave, this is also an indication that the worker may be an employee.
When the worker is an employee…
The school must withhold income tax as well as Social Security and Medicare taxes. Also, the school is responsible for reporting all money paid to the employee during the tax year on a W-2 as well as reporting state and federal unemployment insurance.
Independent contractors normally interact with a person or department that wants a certain service or task completed and typically enters into a contract with specifics on the work to be performed, when it will be completed and the total amount to be paid upon completion. The school does not withhold taxes and employment and labor laws also do not apply to independent contractors. Below are some examples of ways that you can determine if the worker is an independent contractor:
- the worker has a significant investment in his or her work
- the worker is not reimbursed for some or all business expenses
- the worker can realize a profit or incur a loss
When the worker is an independent contractor…
The school may be required to give the worker Form 1099-MISC, Miscellaneous Income, to report what it has paid to the worker.
The worker provides his/her name, address and Taxpayer Identification Number, and certification about back up withholding on a W-9.
The worker is responsible for paying his/her own income tax and self-employment tax. The school does not withhold taxes from the worker’s pay.
Keep everyone on the same page…
Misclassifying a person as an independent contractor when, in fact they are employees, can leave the school facing financial and other penalties. If the IRS suspects fraud or intentional misconduct, it can impose additional fines and penalties, even criminal penalties. Not sure how to sort out how to correctly classify your workforce? Start here.