Definition
Worker classification decides whether the payer treats a worker as an employee or as an independent contractor. The IRS applies a common-law test with three groups of evidence: behavioral control, financial control, and the relationship of the parties. No single factor decides the question. Employees receive Form W-2 and are subject to withholding and payroll taxes. Contractors receive Form 1099-NEC when payments reach the reporting threshold. A business or worker can ask the IRS for a determination on Form SS-8, and some businesses qualify for section 530 relief or the Voluntary Classification Settlement Program.
Why it matters in an audit or review
Misclassification can create payroll tax, interest and penalties. Auditors read contractor agreements, look for contractors who work set hours or use company equipment, and evaluate any exposure as a loss contingency under ASC 450.
Example
Illustrative: a company pays a worker $4,000 a month for a full-time schedule set by the company, using company tools. The facts suggest employee status. If reclassified, the company may owe employer payroll taxes on past pay, which management evaluates for accrual.
Common mistakes
- Relying on the label in a contract instead of the facts.
- Treating relief programs as a determination that the worker is a contractor.
Sources
- IRS, Independent Contractor (Self-Employed) or Employee?: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
- FASB ASC 450-20-25 and 450-20-50, Loss Contingencies
- Section 530 of the Revenue Act of 1978
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error