According to the IRS –
“Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.”
Originally the IRS determined if an individual was an employee or an independent contractor, based on a “Twenty Factor” test. But in January 2006 the process was simplified. Factors considered now fall into one of three categories, i.e. behavioral control, financial control, type of relationship.
|IRS Test||Category||Employee (W-2)||Independent Contractor (1099)|
|Behavior Control||Location||On premises||Off premises|
|Behavior Control||Work Time||Co determined – standard||Contractor determined – non-standard|
|Behavior Control||Staffing Resources||Co determined||Contractor determined|
|Behavior Control||Direction Provided||Direct work process and output||Direct work output only|
|Behavior Control||Training||Co provided||Contractor responsibility|
|Behavior Control||Supplies and Equipment||Company provided||Contractor provided|
|Financial Control||Business Expenses||Generally Reimbursed||Generally Unreimbursed|
|Financial Control||Investment in Process||Insignificant||Significant|
|Financial Control||Degree of Availability||Co is sole customer||Multiple Co customers|
|Financial Control||Pay||Consistent||Not consistent|
|Financial Control||Profit or Loss||No p&l outcome||p&l outcome|
|Type of Relationship||Contract Describing Relationship||What parties call it||What parties call it|
|Type of Relationship||Benefits Eligible||Yes||No|
|Type of Relationship||Degree of Permanence||Permanent work||Temporary work|
|Type of Relationship||Importance of Services Performed||Business critical||Non-business critical|
If after reviewing the IRS established testing you cannot determine the employment status, you have the option of completing and filing a form SS-8, requesting an IRS ruling on the status.
As you can see, in some circumstances employees fall clearly in one or the other camp. However, there can be a very large grey area.
In 2000, the Department of Labor investigated the degree at which mis-classifications occurred. At that time it was determined that 30% of firms mis-classified employees and independent contractors.
In response, federal and state authorities are beefing up auditing to investigate these situations and levying fines against law breakers. Please note the federal government’s newly re-introduced H.R. 3178; and California’s newly enacted SB459.
If it is determined that an employee was misclassified, the employing company will be assessed back taxes, penalties, interest, unpaid personal incomes taxes of the misclassified worker, overtime, benefits, leave entitlement, and other rights and protections due to employees.
If your company has any independent contractors, it may make sense to review the arrangements based on the criteria above.
Please let me know your experiences.© Copyright 2012 Regis Quirin, All rights Reserved. Written For: CFO Tips - What you need to know, to be a CFO TODAY!