The question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. The stakes can be very high when you, the employer, classify the worker incorrectly.
If the worker is an “employee” by federal standards, the company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes (Social Security and Medicare Matching) on the wages, plus FUTA taxes (Federal Unemployment Tax). There may be a state tax obligation as well since most states are more stringent on classification than the IRS is.
The obligations do not apply for a worker who is classified as an “independent contractor”. If the worker is indeed an “independent contractor” they will need to provide you with a W9 and in turn the company who contracted with this individual would send the independent contractor a Form 1099- MISC indicating the amounts for the year showing he/she was paid.
Who is an ‘employee”? Unfortunately, there is no uniform definition of the classification. That being said, most states would disagree with the IRS definition of an “employee”. There are several guidelines you should follow which we have indicated below.
Under the common-law rules (called common-law because they originate from court cases rather than from a statute), an individual generally is an employee if:
the enterprise he/she works for has the right to control and direct them regarding the job they are performing and how they are to do it. This, again, can depend on the type of work the “employee” is performing. There are some instances (based on court cases) where the work has to be performed a certain way due to security or scrutiny of the particular job.
For example, if you “employ” in individual to complete tax work for your particular clients on a seasonal basis, would that person be considered an “employee” or an “independent contractor”? Based on the nature of the business, the individual you “employed” has to use your office, your programs during specified times of business hours. Is this person an “employee” or an “independent contractor”? In these type of instances, you can ask the IRS, using Form SS-8, to rule on whether a worker is an independent contractor or an employee. Please be very specific on the type of work and the nature of the business they will be working in. This can make all of the difference in classification, especially in regards to the stiff penalties imposed.
Some employers that have misclassified workers as independent contractors are relieved from employment tax liabilities under Section 530 of the 1978 Revenue Act (not Internal Revenue Code). In brief, Sec. 530 protection applies only if the employer: filed all federal returns consistent with its treatment of a worker as an independent contractor; treated all similarly situated workers as independent contractors; and had a “reasonable basis” for not treating the worker and an employee.
For example, a “reasonable basis exists if a significant segment of the employer’s industry has traditionally treated similar workers as independent contractors.” Due note, though, Sec. 530 does not apply to certain types of technical workers.
Individuals who are “statutory employees,” (that is, specifically identified by the Internal Revenue Code as being employees) are treated as employees for social security purposes even if they are not subject to an employer’s direction or control (even if the individuals would not be treated as employees under the common-law rules). These individuals are classified as a type of agent driver, commissioned driver, life insurance sales-people, home workers, and full-time traveling sales people who meet a number of other tests. Statutory employees may or may not be employees for non-FICA purposes. Also note, corporate officers are statutory employees for all purposes.
Some categories of individuals are subject to special rules because of their occupation or identities. For example, corporate directors are not employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons.
If you would like to discuss with me how these complex rules apply to your business, or to make sure none of your workers are misclassified, please feel free to contact me or my office to arrange an appointment time.
Tax it Easy,
The Ellem Group
Serving Houston & Beaumont professional tax audit defense. IRS Enrolled Agent on staff.
Trained experts in the tax audit field. The Ellem Group 409-347-7997