Employee and Worker Classification

The classification of workers and employees is essential for determining rights, responsibilities, and protections under labor laws. Correctly classifying workers and employees is critical for several reasons:

Tax and Social Security Contributions: The classification determines who is responsible for paying income tax and social security contributions. Employees usually have their taxes deducted by the employer under PAYE (Pay As You Earn), while workers may be responsible for paying their own taxes.

Legal Compliance: Employers must comply with labor laws and regulations that apply differently depending on the classification of their workers. Misclassification can lead to legal disputes, penalties, and fines for non-compliance.

Employment Benefits: The classification affects which benefits workers are entitled to. Misclassifying an employee as a worker, for example, could lead to the denial of rightful benefits and protections.

Business owner must understand the relationship that exists with each person it pays to perform services. A person performing services for a business may be:

• An independent contractor

• An employee

• A statutory employee

• A statutory nonemployee

The IRS evaluates three primary characteristics to determine the relationship between a business and workers it pays for services:

Behavioral Control: Covers whether the business has a right to direct or control how the work is done.

Financial Control: Covers whether the business has a right to direct or control the financial and business aspects of the worker’s job. Factors include how the worker is paid, whether expenses are reimbursed, and whether tools and supplies are provided.

Type of Relationship: Relates to how the worker and the business owner perceive their relationship, such as whether there are written contracts or employee-type benefits, such as vacation pay or a retirement plan.

Whether a person is classified as an employee, or an independent contractor depends on the facts and circumstances of each individual case.

Statutory Employees

Some workers are classified as statutory employees. Statutory employees are unique because they are issued Forms W-2 by their employers but report their wages, income, and allowable expenses on Schedule C, just like self-employed taxpayers. If a person is a statutory employee, the “statutory employee” in box 13 on their Form W-2 should be checked.

Statutory employees are usually salespeople or other employees who work on commission. The difference is that statutory employees are not required to pay self-employment tax, because their employers must treat them as employees for Social Security tax purposes.

Statutory Nonemployees

There are three categories of statutory nonemployees: direct sellers, licensed real estate agents and certain companion sitters. They are treated as self-employed for federal tax purposes, including income and employment taxes

Compensation for a statutory nonemployee is reported on Form 1099-NEC. The taxpayer then reports the income on Schedule C.

Backup Withholding: If a business does not request a Social Security number or a taxpayer identification number for a payee, such as an independent contractor, it must withhold federal income taxes at a 24% rate in 2023. U.S. source income received by a foreign person (a nonresident alien) is subject to a withholding rate of 30% unless a lower tax treaty rate applies.

The distinction between an employee and a worker is not always straightforward, but it is crucial in determining the rights, responsibilities, and legal protections afforded to individuals. Employees typically enjoy more benefits and security, while workers have fewer rights but still receive basic protections. As the workforce continues to evolve with gig economy trends and flexible work arrangements, it is important for both employers and workers to understand their legal classification and what it means for their rights and obligations.

For businesses, ensuring that workers are correctly classified is essential to avoid legal complications and ensure compliance with employment law. Similarly, workers must understand their legal status to secure the appropriate rights and benefits they are entitled to under the law.