It is critical for businesses to correctly determine whether the those providing services to them are employees or self-employed independent contractors. While it is tempting, as an employer, to treat workers as independent contractors in order to save payroll taxes, failure to categorize them properly can have significant financial consequences.
In general, an employee is considered to be anyone who performs services, if the business can control what will be done and how it will be done. What matters is that the business has the right to control the details of how the worker’s services are done.
On the other hand, independent contractors are normally people who are in an independent trade, business or profession in which they offer their services to the public. For example, doctors, dentists, veterinarians, lawyers, accountants, janitorial services, contractors, and subcontractors are generally treated as independent contractors for tax purposes.
Essentially, whether a worker is an independent contractor or an employee depends on the relationship between the worker and the business. Generally, there are three categories to consider:
Behavioral control − Does the business control or have the right to control what the worker does and how the worker does the job?
Financial control − Does the business direct or control the financial aspects of the worker’s job. Are the business aspects of the worker’s job controlled by the payer? Things like how the worker is paid, are expenses reimbursed, who provides the tools and supplies needed for the job, etc. are important factors.
Relationship of the parties − Are there written contracts or employee type benefits such as pension plan, insurance, vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?
Misclassifying workers as independent contractors adversely affects employees because the employer’s share of taxes is not paid, and the employee’s share is not withheld. If a business misclassified an employee without a reasonable basis, the business can be held liable for employment taxes for that worker.
Generally, an employer must withhold and pay income taxes, Social Security and Medicare taxes, as well as unemployment taxes. Workers who believe they have been improperly classified as independent contractors can use IRS Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation.
If you are a business, and think you may have misclassified workers in the past, what can you do? You may want to consider utilizing something called The Voluntary Classification Settlement Program, or VCSP.
The VCSP is an optional program that provides businesses with an opportunity to reclassify their workers as employees for future employment tax purposes. This program offers partial relief from federal employment taxes for eligible taxpayers who agree to treat their workers as employees in the future. Taxpayers must meet certain eligibility requirements and apply by filing IRS Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
At this point, you may be somewhat confused by just who is considered self-employed.
Generally, someone is self-employed if any of the following apply to them:
They carry on a trade or business as a sole proprietor/independent contractor.
They are a member of a partnership that carries on a trade or business.
They are otherwise in business for themselves. This could include someone who has a part-time business, even if they are an employee elsewhere.
Self-employed individuals, including those who earn money from so-called gig economy ventures, generally must pay self-employment tax, which really is just Social Security and Medicare tax, as well as income tax on their earnings.
Many who are self-employed are also required to file make estimated tax payments four times a year to avoid the underpayment penalty imposed if not enough is paid in throughout the year.
On the plus side, these taxpayers may qualify for a home office deduction, if they use part of a home for business, deductions for business use of their personal vehicle and other business deductions.
Lane Keeter, CPA, is Office Managing Partner of the Heber Springs office of EGP, PLLC, CPAs & Consultants (a full-service financial firm with offices in Heber Springs, North Little Rock and Bryant) and past winner of The Sun-Times Reader’s Choice Award for Best Accountant