Many businesses use independent contractors to help keep their costs down. If you are among them, make sure these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be a costly error.
It can be complex to determine whether a worker is an independent contractor or an employee for federal income and employment tax purposes. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of Federal Insurance Contributions Act taxes on the wages, plus Federal Unemployment Tax Act tax. A business also may 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 do not apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it is $600 or more).
What Are the Factors the IRS Considers?
Who is an ‘employee?’ Unfortunately, there is no uniform definition of the term.
The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they are performing. Otherwise, the individuals are generally independent contractors. However, other factors also are taken into account, including who provides tools and who pays expenses.
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 does not apply to certain types of workers.
Should You Ask the IRS to Decide?
Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.
Businesses should consult with their accountant before filing Form SS-8 because it 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 treat a worker as an independent contractor so that the relationship complies with the tax rules.
Workers who want an official determination of their status also can file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.
If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.
These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you would like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.