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Independent Contractor vs. Employee

January 23, 2018

 

INTRODUCTORY PARAGRAPHS TO BE USED FOR ALL CRITERIA

 

Currently, the likelihood of your business being involved in a worker classification or employment tax audit is increased because the IRS is aggressively attempting to reduce the “tax gap,” which is the annual shortfall between taxes owed and taxes paid.

 

Because the existing worker classification rules are complex and ambiguous, much uncertainty surrounds their interpretation and application. The lack of a single, definitive test for classifying workers as either employees or independent contractors contributes significantly to the worker classification problem.

 

USE FOR ENTITIES WHO PAID INDEPENDENT CONTRACTORS – CRITERION 1, 2, OR 3

 

Therefore, understanding the difference between an employee and an independent contractor is very important. If you are an employer, you are required to withhold and contribute a matching amount of FICA and Medicare taxes from your employee’s income. However, if your workers are independent contractors, you are only required to report payments of $600 or more on a Form 1099-MISC (Miscellaneous Income). Failing to make the right classification could cost you money.

 

If you have workers who make substantial financial investments in tools, equipment, or a place to work, or undertake some entrepreneurial risks, they are probably independent contractors. However, when you control and direct the workers who perform services for you as to the end result and how it will be accomplished, you are probably involved in an employer-employee relationship.

 

Unless there is a reasonable basis for treating your employees as independent contractors, failing to withhold income and employment taxes from their wages can result in severe penalties and interest, in addition to the back taxes owed. Of course, penalties for intentional worker misclassifications are harsher than they are for inadvertent mistakes.

 

Your benefit plan may also be in jeopardy if any eligible employees have been misclassified as independent contractors. Since these employees have been excluded from plan participation, your retirement plan may lose its tax-favored status. The problem is compounded when excluded employees seek restitution for lost benefits not only due to their exclusion from the benefit plan, but also for health coverage and other employee benefits.

 

The IRS offers an amnesty program to eligible employers that have misclassified workers. This program, called the Voluntary Classification Settlement Program (VCSP), allows employers that are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees to prospectively treat the workers as employees, at a cost that is 10 percent of what would normally be owed in a worker misclassification situation. In addition, a safe harbor rule known as “Section 530” provides relief from employment tax obligations with regard to workers, even though those workers may be common-law employees, if certain requirements are met.

 

Since the potential liability is considerable, we feel that it would be beneficial for you to verify that your workers are properly classified. If misclassifications are discovered, we can help you minimize your exposure through use of Section 530 relief or the VCSP.

 

It is also important to review your employment tax records and procedures to ensure that they are in compliance with IRS guidelines, especially in the event of an audit. Please contact our office at your earliest convenience to make an appointment.

 

USE FOR ENTITIES WHO PAID STATUTORY NONEMPLOYEES – CRITERION 4

 

As you probably know, compensation paid to certain workers considered nonemployees is not subject to income tax withholding, FICA or FUTA taxes. Generally, qualified real estate agents and direct sellers are considered statutory nonemployees. For nonemployee classification purposes:

  • Qualified real estate agents must be salespersons (or the person who recruits, trains or supervises salespersons); licensed real estate agents; and compensated based upon their sales or other output, rather than the number of hours they worked.

  • Direct sellers must sell or solicit the sale of consumer products to a customer, or to a buyer for resale, in the home or other non-permanent retail establishment. Workers who perform services related to the delivery or distribution of newspapers or shopping news are also considered direct sellers.

Since your business currently employs statutory nonemployees, we feel that it would be beneficial for you to verify that your workers are properly classified. If misclassifications are discovered, we can help you minimize your exposure through use of Section 530 relief or the Voluntary Classification Settlement Program (VCSP).

 

It is also important to review your employment tax records and procedures to ensure that they are in compliance with IRS guidelines, especially in the event of an audit. Please contact our office at your earliest convenience to make an appointment.

 

USE FOR ENTITIES WHO PAID STATUTORY EMPLOYEES – CRITERION 5

 

As you probably know, sometimes workers are specifically designated as employees by the Internal Revenue Code even if the facts do not suggest an employer-employee relationship. Generally, the following types of workers are considered statutory employees:

  • Full-time traveling or city sales representatives;

  • Agent-drivers or commission-drivers;

  • Life insurance sales representatives; and

  • Home workers.

However, there are distinct rules for each worker type, and their employment tax treatment also varies. In addition, statutory employees must personally perform substantially all of the services required under your contract. These workers cannot have a material investment in your facilities, and your relationship with them must be ongoing.

 

Since your business currently employs statutory employees, we feel that it would be beneficial for you to verify that your workers are properly classified. If misclassifications are discovered, we can help you minimize your exposure through use of Section 530 relief or the Voluntary Classification Settlement Program (VCSP).

 

It is also important to review your employment tax records and procedures, to ensure that they are in compliance with IRS guidelines especially in the event of an audit. Please contact our office at your earliest convenience to make an appointment.

 

IRS Circular 230 Disclosure

Pursuant to U.S. Treasury Department Regulations, information contained in this article is not intended by TOPC Potentia P.C. to constitute a covered opinion pursuant to regulation section 10.35 or to be used for the purpose of (i) avoiding tax-related penalties under Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

 

 




 

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