Employee vs. Independent Contractor: Why Your Classification Matters

Understanding the difference between being classified as an employee versus an independent contractor is not just a tax detail—it’s a crucial distinction that affects your financial responsibilities, legal protections, and benefits.

The classification of whether you are an employee or an independent contractor is important for several reasons:

1. Tax Responsibilities: An employer withholds taxes for Social Security, Medicare, and income tax. Independent Contractors are responsible for paying their own self-employment taxes, which include both the employer and employee portions of Social Security and Medicare.

   
   

2. Workplace Rights and Protections: Employees are entitled to protections such as minimum wage, overtime, unemployment insurance, and workers' compensation. Independent contractors, however, don’t receive these same protections and benefits.

   
   

3. Risk of Misclassification: Employers who misclassify workers risk facing fines, penalties, and back taxes, along with interest from both the IRS and state tax authorities.

   
   

Why It’s Crucial in Specific States

California's ABC Test, created through Assembly Bill 5 (AB5), requires employers to prove three specific criteria before classifying a worker as an independent contractor:

• The worker must not be controlled or directed by the employer in performing their job.

  
  

• The worker must perform work that is outside the usual scope of the employer’s business.

  
  

• The worker must be engaged in a trade or business that they are independently established in.

Along with California, these states also have strict worker classification rules: Massachusetts, New Jersey, Connecticut, New York, and Illinois. In these states, employers must carefully consider both federal and state guidelines to avoid costly mistakes.

Getting your worker classification right is vital to avoid potential penalties and ensure you’re receiving the proper legal protections. If you're unsure of your classification or need assistance navigating these rules for your business, reach out to info@mkhstaxgroup.com for expert advice.