Misclassifying between employee and independent contractor can impact your business finances

As company grows, business owners will eventually hire a professional to fulfill a role within the company. It is important to distinguish an employee and independent contractor before processing the payroll to Employment Development Department and IRS.


The type of classification on employment will generally depends on the industry and profession.


Under the common law rules of employment, an employer-employee relationship exists when a person who hires an individual to perform services has the right to exercise control over the manner and means by which the individual performs those services. The right to control, whether or not exercised, is the most important factor in determining the relationship.


Reasons to properly classify workers

The several reasons why to properly classify an employee and independent contractor. The most important is to prevent additional taxes, penalties, and interest from wrongfully misclassification. As a result from an audit, small business can pay large fines to EDD and IRS, causing a disruption to business. Fines can be backdated since the employee or independent contractor was hired or performed many years ago.


In order to prevent misclassification, business owners, particular in the construction field must understand the difference between an employee and independent contractor.


As business owners, it is critical to think about the long-term consequences for misclassifying between an employee and independent contractor. Ensuring your office manager or human resource specialist follows the regulation with recording keeping of personnel. Keeping inaccurate books can be troubling. By going through a due diligently process to determine employment type, the business will be able to save a lot of headache and avoid penalties from state and federal level in a case of audit.



Having proper documentation and HR policies in place to classify your payroll will be very beneficial in a case of audit. At Profit Pad, we not only keep our clients’ payroll records digitally, but also our employees as well.


Storing these records in our secured cloud allows easy access and control. It is a backup storage for our clients if they lose a hard copy within their department.

Here are some questions to ask:

  • Do you instruct or supervise the person while he or she is working?


  • Can the worker quit or be discharged (fire) at any time?


  • Is the work being performed part of your regular business?


  • Does the worker have a separately established business?


  • Is the worker free to make business decisions which affect his or her ability to profit from work?


Employment determination will depend on the industry and goes through case-by-case process. Audit occurs commonly in the construction industry due to high accident rate and unemployment filing.


For additional information about regulation from EDD, please feel free to contact us at [email protected] and one of our account managers will send free resources to help your business.

Fantasize about having someone else do your bookkeeping? Get a better idea of whether Profit Pad is the right solution with an inside look at how Profit Pad does your bookkeeping.

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