Abstract: Many businesses use independent
contractors to help keep their costs down — especially in these times of staff
shortages and inflationary pressures. Businesses that use independent
contractors should be careful that these workers are properly classified for
federal tax purposes. If the IRS reclassifies them as employees, it can be an
expensive mistake.
Many
businesses use independent contractors to help keep their costs down and
provide flexibility for short-term needs.
If you’re among those businesses, be careful that these workers are
properly classified for federal tax purposes. If the IRS reclassifies them as
employees, it can be an expensive mistake.
The
question of whether a worker is an independent contractor or an employee for
federal income and employment tax purposes is a complex one. If a worker is an
employee, your company must withhold federal income and payroll taxes, pay the
employer’s share of Social Security and Medicare taxes on the wages, and pay federal
unemployment tax. A business may also provide the worker with fringe benefits
if it makes them available to other employees. In addition, there may be state
tax obligations.
On
the other hand, if a worker is an independent contractor, these obligations
don’t apply. In that case, the business simply sends the contractor a Form
1099-NEC for the year showing the amount paid (if it’s $600 or more).
Key
factors
Who’s
an “employee?” Unfortunately, there’s no one definition of the term. The IRS
and courts have generally ruled that one of the key factors that determines the
difference between an employee and a contractor is the right to control and
direct the person in the jobs they’re performing, even if that control isn’t
exercised. The issue of control is evaluated by asking several questions,
including:
· Who sets the
worker’s schedule?
· Are the worker’s
activities subject to supervision?
· Is the work
technical in nature?
· Is the worker free
to work for others?
Another
important factor is whether the worker has the opportunity for profit or loss
based on his or her managerial skills. That is, can the worker apply
independent judgment and business acumen to affect the success or failure of
the work being performed? If there’s a lack of such opportunity, that’s one
indication of employee status.
Some
employers that have misclassified workers as independent contractors may get
some relief from employment tax liabilities under Section 530. This protection
generally applies only if an employer meets certain requirements. For example,
the employer must file all federal returns consistent with its treatment of a
worker as a contractor and it must treat all similarly situated workers as
contractors. Note: Section 530 doesn’t apply to certain types of workers.
Be wary
before asking the IRS
You
can ask the IRS (on Form SS-8) to rule on whether a worker is an independent
contractor or employee. However, you should also be aware that the IRS has a
history of classifying workers as employees rather than independent
contractors. So, before you file Form SS-8, contact us for a consultation.
Filing this form may alert the IRS that your business has worker classification
issues — and it may unintentionally trigger an employment tax audit. It may be
better to properly set up a relationship with workers to treat them as
independent contractors so that your business complies with the tax rules.
Workers
who want an official determination of their status can also file Form SS-8. Dissatisfied
independent contractors may do so because they feel entitled to employee
benefits and want to eliminate their self-employment tax liabilities. If a
worker files Form SS-8, the IRS will notify the business with a letter that
identifies the worker and includes a blank Form SS-8. The business will be asked
to complete and return the form to the IRS, which will render a classification
decision.
Need more help?
This
article lists the basic rules. If you have questions, contact us to assist you
in ensuring that your workers are properly classified.
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