Today’s workplace is more diverse than ever. Many companies have found benefits in hiring independent contractors to complete work that they do not need to have a full-time in-house employee handle. Yet, it is critical to know how to properly classify your employees and independent contractors according to IRS rules, as it can impact your tax obligations.
How Does the IRS Decide Whether an Individual Is an Employee or an Independent Contractor?
The IRS needs to better understand the relationship that an employee or independent contractor has with a business. This designation often comes down to evidence about the “degree of control” and independence that an independent contractor does or does not have.
Some common questions used to differentiate employees and contractors include:
- Does the company manage what the individual does and how they do this work?
- How does the company pay the worker, reimburse expenses, and/or provide supplies and tools?
- Does the company offer health insurance, PTO, and/or retirement benefits to the worker?
Every situation is different, and it is up to the company to determine the proper classification for their workers.
How Can IRS Form SS-8 Help Classify Workers as Employees or Independent Contractors?
IRS Form SS-8 can help with verifying whether a worker is an employee or contractor. This form allows the company to fill out all information requested, either as the business or the worker, and then submit it to the IRS. The IRS will then analyze the information to determine the proper designation. This process can take six months, though.
What Are the IRS Forms and Employment Taxes for Employees?
Employers are responsible for various taxes for their employees. These employment taxes include federal income tax, Social Security tax, and Medicare tax. Employers must collect, deposit, and report employment taxes to the IRS.
Numerous tax forms exist for employers to use for this, including:
- Employment Eligibility Verification: Form I-9
- Withholding Certificate for Employee: Form W-4,
- Withholding Certificate for Pension or Annuity Payments: Form W-4P
- Request for Taxpayer Identification Number and Certification: Form W-9
- Pre-Screening Notice and Certification Request for the Work Opportunity and Welfare-to-Work Credits: Form 8850
What Are the IRS Forms and Taxes for Independent Contractors?
Independent contractors are treated differently than employees by employers. Once you verify a worker is an independent contractor, they need to submit a W-9 form to you. This form includes the necessary information you need to report what you pay the contractor to the IRS.
Form 1099-NEC (Nonemployee Compensation) then allows you to report the compensation to the IRS and to the employee using Form 1099-MISC in box 7. You do not collect taxes on behalf of the worker.
What Is the IRS Penalty for Misclassifying an Employee as an Independent Contractor?
Though most employers do what they can to ensure that they classify workers properly, there are risks to making a mistake here. The IRS can issue a fine or penalty for this misclassification. Penalties start at $50 but can be much higher, especially if there is evidence that you misrepresented employee status deliberately.
In addition to penalties, the business and its owners are responsible for any unpaid employment taxes.
Who Is Responsible for Employment Tax Liability for Misclassification of Employees?
In some situations, if an employer is found to have misclassified an employee, the employer can be held responsible for that mistake. This may lead to the employer having to pay penalties for the mistake and also to be liable for all employment taxes that they should have collected for the employee but did not do so.
The employer will need to pay all income taxes, Medicare taxes, unemployment taxes, and Social Security taxes related to that employee.
Does the IRS Offer Tax Relief for Businesses and Business Owners When They Owe Taxes as a Result of Misclassifying an Employee?
In situations where this occurs, the IRS may accept an installment agreement or other tax relief to repay employment taxes. This depends on various factors, including if the business is found to have deliberately classified the worker as an independent contractor instead of an employee, in which case they may not.
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