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. If the IRS reclassifies them as employees, it can be a costly error.

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, your 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 including who provides tools and who pays expenses.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat 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 your 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.

Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.

If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.