WHAT DO YOU KNOW ABOUT Worker Misclassification?

Did you known that the IRS can seek back payroll taxes and penalties from businesses that wrongly treat workers as contractors instead of employees?  Some studies show that between 10 - 20 % of employers misclassify at least one worker. This sort of misclassification occurs when a worker who should be considered a direct EMPLOYEE (and receive a Form W-2 to file with their tax returns) is treated as an INDEPENDENT CONTRACTOR (and receives a Form 1099) instead.

 It may not sound like a big deal, but it is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.

 Generally, employers must withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. They do not generally have to withhold or pay any taxes on payments to independent contractors, who are ineligible for such benefits. 

 The IRS looks at three categories of control and independence in the business relationship to determine how workers should be classified:

    1. Behavioral:  Does the company control (or have the right to control) what the worker does and how he/she does the job?

    2. Financial:  How is the worker paid? Are expenses reimbursed? Who provides tools and supplies? Is the worker able to work for more than one firm, etc.?

    3. Type-of-relationship:  Are there written contracts or benefits such as a pension plan, insurance, vacation pay, etc.? Will the work relationship continue indefinitely, or only for a specific project?

 Businesses must look at the entire relationship and weigh all of these aspects when determining whether a worker is an employee or independent contractor; no one factor stands alone in making this determination.

 The costs of worker misclassification to tax and social insurance systems, and to the workers, add up. Businesses that misclassify fail to pay mandatory payroll taxes such as Social Security and Medicare (FICA), unemployment insurance (UI), and workers’ compensation insurance. The independent contractor is made responsible for the full FICA tax, rather than half. The loss of billions of dollars in tax revenue creates a significant financial burden for local, state, and the federal governments, not only due to lost revenue but also because of the added cost of providing social services to uninsured workers. Businesses can also be harmed by the practice of worker misclassification, when law-abiding companies that pay their taxes and properly classify their workers could face a competitive disadvantage.

 If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.

 Workers who believe they have been improperly classified as independent contractors by an employer can file an IRS Form 8919 to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation. By filing this form, their social security earnings will be credited to their social security record.

 For more information, you can visit this IRS page.

 If you would like our assistance with determining worker classification, give us a call: 251-476-7685.