If you’re one of the many businesses that use independent contractors to help keep down costs, you’ll want to ensure that these workers are classified properly for federal tax purposes. It can be a costly mistake if the IRS reclassifies them as employees.
Determining whether a worker is an employee or an independent contractor for the purposes of federal income and employment tax can be complex. If a worker is an independent contractor, businesses must simply send the contractor a Form 1099-NEC for the year showing the amount paid if the amount is $600 or more.
However, if the worker is an employee, the company must withhold federal income and payroll taxes as well as pay the employer’s share of FICA taxes on the wages—in addition to FUTA tax. There may also be state tax obligations, and the business may provide the worker with fringe benefits that it makes available to other employees.
Factors considered by the IRS
Unfortunately, there isn’t a uniform definition for the term “employee”.
Generally speaking, if the organization an individual works for has the right to direct and control them in the jobs they’re performing, the IRS and courts have typically ruled that the individual is an employee. Otherwise, an individual is generally classified as an independent contractor. However, other factors—such as who pays expenses and who provides tools—are also taken into account.
Under Section 530, employers may get some relief from employment tax liabilities if they’ve misclassified workers as independent contractors. However, the employer must also meet certain requirements, such as treating all similarly situated workers as contractors and filing all federal returns in a way that’s consistent with its treatment of a worker as a contractor.
It’s also worth noting that section 530 doesn’t apply to certain types of workers.
Form SS-8 and allowing the IRS to decide
It’s possible to ask the IRS to rule on whether a worker is an employee or independent contractor by filing Form SS-8. However, the IRS historically has tended to classify workers as employees rather than independent contractors.
Before you file Form SS-8, you should first consult with us. Filing Form SS-8 could unintentionally trigger an employment tax audit by signalling to the IRS that your business has worker classification issues.
It’s often better to focus on properly treating workers as independent contractors so that their employment status complies with the tax rules.
Form SS-8 can also be filed by workers who want the IRS to officially determine their status. Independent contractors who are disgruntled because they feel entitled to employee benefits or who want to avoid self-employment tax liabilities may file a Form SS-8.
If a worker does so, the IRS notifies the business by mail in a letter. This letter will identify the worker and include a blank Form SS-8. The IRS will request that the business complete and return the form, and it will then render a classification decision.
Although this covers the basic tax rules, there are always new developments. The U.S. Labor Department recently withdrew a non-tax rule that was introduced under the Trump administration and made classifying workers as independent contractors easier. If you have questions about how to classify workers at your business, contact us. We can help you ensure that your workers are classified properly.