Abstract: If
a business engages independent contractors to address staffing needs, it needs
to be careful that these workers are properly classified for federal tax
purposes. This article reviews the general rules for distinguishing an
independent contractor from an employee.
Worker classification is still important
Over the last year, many companies
have experienced “workforce fluctuations.” If your business has engaged independent
contractors to address staffing needs, be careful that these workers are properly classified
for federal tax purposes.
Tax
obligations
The
question of whether a worker is an independent contractor or an employee for
federal income and employment tax purposes is a complex one. If a worker is an
employee, the company must withhold federal income and payroll taxes, and pay
the employer’s share of FICA taxes on the wages, plus FUTA tax. Often, a
business must also provide the worker with the fringe benefits that it makes
available to other employees. And there may be state tax obligations as well.
These
obligations don’t apply if a worker is an independent contractor. In that case,
the business simply sends the contractor a Form 1099-NEC for the year showing
the amount paid (if the amount is $600 or more).
No
uniform definition
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, though other factors are considered.
Some
employers that have misclassified workers as independent contractors may get
some relief from employment tax liabilities under Internal Revenue Code Section
530. In general, this protection applies only if an employer filed all federal
returns consistent with its treatment of a worker as a contractor and treated all
similarly situated workers as contractors.
The
employer must also have a “reasonable basis” for not treating the worker as an
employee. For example, a “reasonable basis” exists if a significant segment of
the employer’s industry traditionally treats similar workers as contractors. (Note:
Sec. 530 doesn't apply to certain types of technical services workers. And some
categories of individuals are subject to special rules because of their
occupations or identities.)
Asking for a determination
Under certain circumstances, you may
want to 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.
Consult
a CPA before filing Form SS-8 because doing so may alert the IRS that your company
has worker classification issues — and inadvertently 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.
Latest developments
In
January 2021, the Trump Administration published a final rule revising the Fair
Labor Standards Act’s employee classification provision. The rule change was
considered favorable to employers. However, as of this writing, the Biden
Administration has delayed the effective date of the final rule change. Stay
tuned for the latest developments and contact us for any help you may need with
employee classification.
© 2021