Employment Taxes
Employment taxes are a common area where businesses can run into trouble with the Internal Revenue Service (IRS). One area of frequent problems is related to how business owners classify workers as either:
- Employee
- Independent Contractor
- Unpaid Interns
If an individual is an employee, business owners generally withholds income tax, as well as withholding and paying Social Security and Medicare taxes, and paying unemployment tax on wages paid to the employee.
If an individual is an independent contractor, business owners generally do not withhold any taxes from payments to the contractor.
Misclassifying an individual can have serious tax consequences for business owners, including liability for past taxes, FICA and federal unemployment tax. Here are some things you should know to avoid employment tax problems.
Employees or Independent Contractors?
The IRS and the courts apply a 20 factor test to help determine if an individual is an employee or independent contractor. It focuses on control of the worker. See the IRS website for the factors and elements used to determine an individuals status:
Still not sure if an individual is an employee or an independent contractor? Use Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will make an official designation of individuals’ status as employee or independent contractor. It is important to note that it may take up to 6 months for a ruling by the IRS.
Tax Reporting for Independent Contractors
- Form W-9 Request for Taxpayer Identification Number and Certification
Business owners should ask independent contractors to supply them with a Form W-9.
- Form 1099
In most cases, if a business owner pays a contractor more the $600 in a year, they must file a Form 1099 with the IRS and supply the contractor with a copy.
- Form W-2
Business owners must file Form W-2 for employees earning more than $600 in a year.
Tax Penalties for Misclassifying Workers
If you misclassify an employee as an independent contractor you may owe:
- Back taxes
- Penalties and interest
Unpaid Interns
The Department of Labor has issued guidelines to help businesses determine if a temporary worker can be treated as an unpaid intern or if the work should be classified as a paid employee. Here are the guidelines:
If an individual has been misclassified as an unpaid intern, the employer may owe:
- Back taxes
- Penalties and interest
Safe Harbor Rules
If the IRS determines an individual is an employee and not an independent contractor, the employer may qualify for relief from back employment taxes under the safe harbor exemption (Revenue Act of 1978, Section 530). The safe harbor exemption applies to federal employment taxes, not state taxes.
Requirements
Under Section 530, a business is not treated as an employer, regardless of the 20 factor test, if it has a reasonable basis for treating worker as an independent contractor. In order to qualify for the safe harbor exemption, employers:
- Must always treated worker as independent contractor
- Must have filed Forms 1099 for all contractors
- Must not have treated similar workers as contractors
Voluntary Classification Settlement Program (VCSP)
Similar requirements to Section 530 Safe Harbor rules, but for businesses not currently under audit.
More Information
For more common tax problems, see my posting on Choice of Entity.