Independent contractors are often used by organizations to help keep their costs down — especially in these times of staff shortages and inflationary pressures. If you have workers that fall into this category, be careful to make sure that they 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 can be complex. If a worker is an employee, your organization must withhold federal income and payroll taxes and pay the employer’s share of Federal Insurance Contributions Act taxes on the wages, plus Federal Unemployment Tax Act tax. An organization 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 don’t apply. In that case, the organization simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).
No One Definition
Who’s an ‘employee?’ Unfortunately, there’s 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’re 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 doesn’t apply to certain types of workers.
You Can Ask The IRS But Think Twice
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, you also should be aware that the IRS has a history of classifying workers as employees rather than independent contractors.
Organizations should consult with us before filing Form SS-8 because it may alert the IRS that your organization 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 organization complies with the tax rules.
Workers who want an official determination of their status also can 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 organization with a letter. It identifies the worker and includes a blank Form SS-8. The organization is asked to complete and return the form to the IRS, which will render a classification decision.
These are the basic tax rules. Contact us if you’d like to discuss how to classify workers at your organization. We can help make sure that your workers are properly classified.