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The determination of whether a worker is an employee or independent contractor is an important decision for businesses owners to make. Hiring workers can involve potential liabilities and added reporting requirements, while the improper classification of a worker as an independent contract, rather than an employee, can result in severe penalties from the IRS and Department of Labor. In an effort to simplify this determination the State of Michigan has announced implementation of the IRS’ 20-Factor test.

Effective January 1, 2013, Michigan’s Unemployment Insurance Agency (MI-UIA) adopted the IRS’ 20-Factor test used to determine whether a worker is an employee or an independent contractor. The 20-Factor test implemented by the MI-UIA focuses on the control an employer has over the worker and the factors are grouped into the three categories of Behavioral Control, Financial Control, and Relationship Factors. An example of some factors included on the test would be who sets the worker’s hours of work, where is the work performed, who furnishes tools and materials to the worker, and whether the worker can quit without breach of contract. If a worker is required to comply with instructions of where, when, and how they should work, the worker would most likely be considered an employee. If the worker is not under supervision, determines their own work schedule, and is responsible to the employer on a results-only basis, they would normally be considered an independent contractor. Because of the multiple factors involved it is important to apply the test on a case-by-case basis.

Based on the results of the 20-Factor test, a business will be able to make the proper determination for a worker to be classified as an employee or independent contractor. If determined to be an employee, the business will be responsible for proper withholding of Federal and state taxes from the worker’s wages and issuing a W-2 to the individual at year’s end. A classification as an independent contractor requires no withholdings from the payments made to the worker and the business will instead issue a Form 1099 to the individual at year’s end.

The misclassification of a worker can result in problems with the IRS and Department of Labor in addition to exposing the business to penalties, additional taxes, and potential litigation. Although the test may be seen as complex, careful application of the test will help businesses avoid potential issues that can arise.

Please contact our Steve McCarty, National PEO Practice Leader, for more information.