Ensure Compliance When Hiring an Independent Contractor

In times of staffing shortages and inflation, many businesses turn to independent contractors to manage costs. If you're considering this approach, it's crucial to properly classify these workers for federal tax purposes. Misclassifying employees as independent contractors can lead to audits, back taxes, penalties, and lawsuits if the IRS intervenes.

Understanding Worker Classification

Tax law requirements differ for employees and independent contractors. Determining a worker's status for federal income and employment tax purposes can be complex. If a worker is classified as an employee, your business must:

• Withhold federal income and payroll taxes
• Pay the employer's share of FICA taxes
• Pay federal unemployment (FUTA) tax
• Potentially offer fringe benefits available to other employees
• Comply with additional state tax requirements

In contrast, if a worker qualifies as an independent contractor, these obligations generally don't apply. Instead, the business issues Form 1099-NEC at year-end when payments total $600 or more during the calendar year. Independent contractors typically have multiple clients, use their own tools, invoice customers, receive payment under contract terms, and have the opportunity to earn profits or suffer losses on jobs.

Defining an Employee

What defines an "employee"? Unfortunately, there's no single standard. Generally, the IRS and courts examine the degree of control an organization has over a worker. If the business directs and controls how the work is done, the individual is likely an employee. Employees usually have tools and equipment provided to them and don't incur unreimbursed business expenses.

Some businesses that misclassify workers may qualify for relief under Section 530 of the tax code, but only if specific conditions are met. These include treating all similar workers consistently and filing all related tax documents accordingly. Note that this relief doesn't apply to all types of workers.

Proceeding Cautiously with Form SS-8

Businesses can file Form SS-8 to request an IRS determination on a worker's status. However, this can backfire. The IRS often leans toward classifying workers as employees, and submitting this form may draw attention to broader classification issues, potentially triggering an employment tax audit.

It's often wiser to consult with experts to ensure your contractor relationships are properly structured from the outset, minimizing risk and ensuring compliance. For example, use written contracts that clearly define the nature of the relationships, maintain documentation that supports the classifications, apply consistent treatment to similar workers, and take other steps.

When a Worker Files Form SS-8

Workers can also submit Form SS-8 if they believe they're misclassified, often seeking employee benefits or to reduce self-employment tax. If this happens, the IRS will contact the business, provide a blank Form SS-8, and request it be completed. The IRS will then evaluate the situation and issue a classification decision.

Avoid Costly Mistakes

Worker classification is a nuanced area of tax law. If you have questions or need guidance, reach out to the experts on our team. They can help you accurately classify your workforce to avoid costly missteps.