How Workers are Classified is Important

It is probably no surprise to you or anyone with a pulse that many companies experienced “workforce fluctuations” in 2020. If your business has turned independent contractors to address staffing needs, you must properly classify them for federal tax purposes.

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, the company must withhold federal income and payroll taxes, as well as pay the employer’s share of FICA and FUTA on the wages. Additionally, the business must be fair with the fringe benefits it gives to employees and meet all state tax obligations.

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.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. In general, this protection applies only if an employer filed all federal returns consistent with its treatment of a worker as a contractor and treated 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.)

The IRS Can Help You Make 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, for obvious reasons.

Give us a call before filing Form SS-8 because doing so may alert the IRS that your company has worker classification issues — and may 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.

Latest Developments

In January 2021, the Trump Administration published a final rule revising the Fair Labor Standards Act’s employee classification provision. The rule change was considered favorable to employers. However, as of this writing, the Biden Administration has delayed the effective date of the final rule change. Stay tuned for the latest developments and contact us for any help you may need with employee classification.

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