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August 15, 2024 •HoganTaylor
Many businesses rely on independent contractors to manage costs and gain flexibility for short-term projects. However, it's crucial to ensure these workers are correctly classified for federal tax purposes. Misclassification can lead to significant financial consequences if the IRS determines that these workers should be treated as employees.
Determining whether a worker is an independent contractor or an employee for federal income and employment tax purposes can be complex. If a worker is classified as an employee, the business is responsible for withholding federal income and payroll taxes, paying the employer’s share of Social Security and Medicare taxes, and covering federal unemployment tax. Additionally, the company may need to offer fringe benefits if they are provided to other employees, along with meeting any applicable state tax obligations.
In contrast, if a worker is deemed an independent contractor, these obligations do not apply. The business is only required to issue a Form 1099-NEC at the end of the year if the contractor earns $600 or more.
The definition of an "employee" is not straightforward, as it varies depending on the context. However, one critical factor is the degree of control the business has over the worker. This includes the ability to direct and oversee the work performed, even if that control is not actively exercised. Questions to consider include:
Another important consideration is whether the worker has the opportunity for profit or loss based on their managerial skills. An independent contractor should have the ability to use their judgment and business acumen to influence the success or failure of their work. A lack of such opportunities may suggest an employee relationship.
For employers who may have misclassified workers, relief from employment tax liabilities might be available under Section 530 of the Revenue Act of 1978. To qualify, employers must meet specific criteria, such as consistently filing all federal returns in a manner consistent with treating workers as contractors and uniformly treating all similarly situated workers as contractors. However, Section 530 does not apply to certain categories of workers.
Businesses can request a determination from the IRS on a worker's status using Form SS-8. However, it is important to be aware that the IRS often favors classifying workers as employees. Submitting Form SS-8 may inadvertently trigger an employment tax audit. It might be more prudent to structure the relationship properly from the beginning to ensure compliance with tax rules.
Workers can also file Form SS-8 if they believe they should be classified as employees. This is sometimes done to gain access to employee benefits or to avoid self-employment tax liabilities. If a worker files this form, the IRS will notify the business and request a response, which will influence the final classification decision.
This article provides an overview of the essential rules for classifying workers. For specific advice tailored to your business, it's best to consult a tax professional who can help ensure that your workers are properly classified and that you remain compliant with all applicable regulations. Contact us for a consultation to navigate these complex issues.
If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax practice, please email Tony Otto, Tax Practice Lead, at jotto@hogantaylor.com.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.