Classifying as Employee vs. Independent Contractor
Classifying workers as independent contractors rather than employees is often preferred by businesses. While using an independent contractor lessens a company’s control over the worker’s day-to-day activities, it lessens the tax responsibility of the company. It is important to note that the IRS is on the lookout for companies that classify workers that should be employees as independent contractors.
The Importance of Classification
When classifying a worker as an employee, companies must withhold federal income tax and the employee’s share of Social Security and Medicare taxes. The business must, in turn, pay the employer’s share of these taxes, pay federal unemployment tax, file federal payroll tax returns and follow other IRS and U.S. Department of labor policies.
Businesses may also be required to pay state and local unemployment and workers’ compensation taxes and comply with other rules for employees. These costs can place a significant financial burden each year.
Independent contractor status allows companies to avoid employment tax concerns. Independent contractors also do not have to be provided with fringe benefits such as health insurance, retirement plans, or paid vacations. If $600 or more is paid to an independent contractor during the year, a Form 1099-MISC must be filed with the IRS, and a copy must be sent to the worker with what they were paid. That is the extent of your bureaucratic responsibility to an independent contractor.
However, if an independent contractor is determined by the IRS actually to be an employee, your business could be assessed for unpaid payroll taxes plus interest and penalties. Mistreatment of an employee as a contractor can also cause you to be liable for employee benefits that should have been provided but were not, including penalties under federal law.
Filing with the IRS
To determine if a worker is an employee or an independent contractor, an optional IRS Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” can be filed. Once submitted, the IRS will issue a decision on how to classify a worker. Be aware that the IRS has a history of preferring to classify workers as employees rather than independent contractors.
Businesses should consult with us before filing Form SS-8 because the submission of the form can alert the IRS that your business has issues with classification and inadvertently trigger an employment tax audit.
Best practice is simply to treat independent contractors so that the relationships comply with tax rules. These rules include not dictating how contractors perform their duties, ensuring that you are not the workers’ only customer, providing annual Forms 1099, and essentially not treating the workers as you would an employee.
Workers Requesting Determination
Workers can also request a determination of their status by filing Form SS-8. Generally, the determination is requested by workers who feel entitled to employee benefits and want to eliminate self-employment tax liabilities.
When a worker files an SS-8 form, a letter will be sent to the business. The letter identifies the worker and includes a blank SS-8 form. The IRS requests that the business fills out the form, which will render a classification decision.
Defending your Classification
If workers are properly classified, a worker filing an SS-8 is no reason to panic. Contact us before sending a reply to the IRS. The proper response can often allow you to continue to classify the worker as a contractor. We can also assist in setting up independent contractor relationships that will comply with IRS policy. Contact us at 818-334-8623 or click here, and we will contact you.