Who is an employee and what must you do?
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. As an employer, you are required to withhold and to contribute a matching amount of FICA and Medicare taxes from your employee's income.
Who is an independent contractor and what must you do?
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. If your workers are independent contractors, you are onlyrequired to report payments of $600 or more on a Form 1099-MISC (Miscellaneous Income).
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.
The IRS uses three characteristics to determine the relationship between businesses and workers:
- Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.
- Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.
- Type of Relationship relates to how the workers and the business owner perceive their relationship.
If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.
If you can direct or control only the result of the work done -- and not the means and methods of accomplishing the result -- then your workers are probably independent contractors.
Workers can avoid higher tax bills and lost benefits if they know their proper status.
Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.
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.
You can learn more about the critical determination of a worker's status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link. Or -- contact us for an assessment.