Starting a business is an exciting–and stressful–endeavor. When you are just starting, you may be relying on yourself and only a couple of other people. As your business grows, you may need to take on more people to help keep the progress going. As that happens, it will be important for you to understand how to classify the potentially different types of workers on your team.
What to know about classifications
Generally, you will classify your workers as either part-time employees, full-time employees, exempt/non-exempt employees, or independent contractors. The difference between these classifications dictate whether a worker is entitled to benefits, or overtime pay, and how their compensation should be taxed.
In the simplest of terms, to determine whether someone has been classified correctly, the IRS and Minnesota agencies will consider three different factors:
- Who has control over the work?
- Who controls the finances?
- What is the actual relationship between employer and worker like?
Generally speaking, an employee has less control over how he or she performs the work and the financial aspects of the job. An independent contractor will have more control over these elements and may provide their services to multiple parties.
Furthermore, a person would likely be perceived as an employee if he or she can quit without liability, performs work that is central the employer’s business, and has a continued relationship with the employer.
For example, if a dog-grooming business brings on a dog groomer, the groomer will more likely be classified as an employee than a contractor; however, if the dog-grooming business brings on someone to provide marketing services, that person is more likely a contractor.
Other factors come into play, e.g., bringing on an individual to provide services to the business will more likely result in an employee classification than if the services are provided by someone operating as an LLC or other legal entity.
Consequences of misclassification
Too often, employers will incorrectly classify an employee as a contractor to avoid legal obligations like paying overtime, providing job-protected leave, and paying federal and state taxes. They may think doing so is a harmless way to cut costs, but in reality, it can create a very expensive problem.
If you misclassify a worker–intentionally or not–you could face serious fines and penalties for ever instance of misclassification, which could dramatically impact your new business. In other words, improperly classifying your workers can be an expensive mistake.
If you have questions about how to classify your workers, or you want to be sure you have done so properly, you can discuss your situation with an attorney, or contact the IRS for a determination. For more information on this topic, check out Sjoberg & Tebelius attorney Anne G. Brown’s article here.