The IRS wants to help you with worker classification
The working world isn’t what it used to be. With mobile technology widely available and so many jobs lost following the 2008 financial crisis, many workers have gone solo. These independent contractors can be a great boon to employers looking for expertise on a short-term basis. But they also bring the risk of worker misclassification — and unwanted IRS attention.
Employment laws don’t require you to pay independent contractors minimum wage or overtime — or provide them with any of the employee benefits you may provide employees. Moreover, you don’t need to pay the employer portion of Social Security and Medicare (FICA) taxes or withhold federal, state and local income taxes or the employee portion of FICA taxes. But making the distinction between an independent contractor and an employee can be tricky. And if you choose incorrectly, the IRS could hold you liable for the taxes that you should have paid or withheld for that worker — and penalize you for not having done so.
The distinction between employee and independent contractor typically is determined by the amount of control the company has over the way in which the person works and by the support given to that worker. To steer clear of IRS trouble, explain your desired results to the independent contractor and provide a deadline, but leave how, when and where the work is done to the worker.
- Be sure that the worker uses his or her own transportation, equipment and supplies.
- Require invoices. Independent contractors should give you a total cost estimate for their work, rather than just an hourly or monthly rate. Ask them to submit invoices on completion or, if the work takes more than a month or two, a series of invoices. At year end, file a Form 1099-MISC for each contractor to whom you paid at least $600 during the year.
- Look for professional operations as well. Independent contractors should have their own workspace and resources. Like other businesses, they should market their services and carry business insurance. Use those who work for companies other than yours. If a contractor’s tax return includes only one Form 1099-MISC, the IRS might challenge his or her status.
- Be mindful of industry norms, too. The IRS knows that some industries hire independent contractors more than others. For example, builders often hire independent carpenters, electricians and other tradespeople. If your industry doesn’t typically use independent contractors, diligently follow the basic control and support rules as well as those regarding invoicing.
- Finally, consult an employment law attorney to develop a policy for hiring independent contractors, and have him or her prepare work-for-hire contracts.
If you fear you’ve already inadvertently fallen out of compliance with worker classification rules, the IRS has a program that can help you out. Under its Voluntary Classification Settlement Program (VCSP), a company that currently treats its workers (or a class or group of workers) as independent contractors or other nonemployees may voluntarily reclassify the workers as employees, rather than independent contractors, for future tax periods.
To qualify, you must have consistently treated the workers as nonemployees and have filed the required Forms 1099 for the preceding three years. You cannot currently be under an audit by the IRS, the Department of Labor or a state governmental agency. (Additional eligibility requirements may apply.) If you qualify, your liability for past payroll obligations will be reduced to 10% of the employment tax liability that may have been due on compensation paid to the workers in question for the most recent tax year as determined under Section 3509 of the Internal Revenue Code.
More relevant than ever
Employee misclassification is even more relevant right now, given the recently upheld health care law and its potential penalties (starting in 2014) for not providing health care coverage to employees. Also bear in mind that state laws regarding employee / independent contractor status vary, and a worker could be classified one way for federal purposes and another for state purposes. Work with your tax advisor and attorney to determine hether you’re on safe ground.
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