It is imperative that business owners correctly determine whether individuals that provide services are properly classified as employees or independent contractors.
For an employee, a business owner must withhold income tax, withhold as well as pay Social Security and Medicare taxes plus pay unemployment tax on all wages earned. On the other hand, a business owner generally does not have to make the above tax payments, nor withhold taxes on behalf of independent contractors, as this arrangement indicates that the worker is self-employed. And self-employed workers hold responsibility for remitting and funding the individual and employer's share of the taxes, known as self-employment taxes (excluding unemployment taxes).
So, a business owner may be tempted to reduce their expenses by improperly classifying an individual as an independent contractor, which avoids paying the employer's share of Social Security, Medicare and unemployment taxes. This ‘savings’ leads to many businesses treating employees as independent contractors to save a buck. Not only does this cause an unpleasant surprise for the employee at tax time, but it may also lead to steep fines for the business that knowingly misclassifies employees.
Before determining how to treat payments made for services, one must first know the business relationship that exists between the business owner and the individual performing the services. In determining whether the person providing the service is an independent contractor or employee, all information that provides evidence of the degree of control and independence must be considered. The general rule is that an individual is an independent contractor if the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
Facts that provide evidence of the degree of control and independence fall into three categories:
· Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
· Financial: Are the business aspects of the individual's job controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
· Type of Relationship: Are there written contracts or employee type benefits such as a pension plan, insurance, vacation pay, etc.? Will the relationship continue and is the work performed a key aspect of the business?
All of the above factors are used in determining whether an individual is an employee or independent contractor. The key is to look at the entire relationship and the degree of the right to direct and control. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action.
If after reviewing the three categories above, an individual feels that they were misclassified as an independent contractor and should be treated as an employee, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS. The IRS will review the facts and circumstances and officially determine the individual's status. If the IRS determines that an individual has been improperly classified as an independent contractor, the business will be held liable for the employment taxes of the individual (both the employer and employee portion). However, caution is advised for individuals that are still providing services for the business in question, as there could be undesirable consequences as a result of the filing. A taxpayer can always complete the Form SS-8 and an amended return when they are no longer providing services or receiving payments from the business.
For more information and resources on the topic of Independent Contractor vs. Employee, please see Independent Contractor vs. Employee or contact your local income tax preparation office for assistance.
Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.