Are You Risking An Audit For Paying Employees As Contractors?
Is a worker an employee or independent contractor?
A loaded question
About a hot topic
Without clear cut guidelines . . . let the fun begin!
Honestly, one blog post can't do justice to such an exceptionally complex and important issue. There is no checklist to go by that gives a difinitive answer.
The courts and Congress have been ruling on employment issues for decades. There are a lot of cases and regulations to use as guidance, but classification is still decided on a case-by-case basis.
The IRS recognized that work environments change over time, and will adjust what factors it consideres important in making determinations to reflect these changes. But, be aware the IRS perfers employees over contractors.
What worked in the past isn't guaranteed to work today.
Folks may have gotten away with playing fast and loose with the rules before, but those days are over.
I want to clear up some common misconceptions and misunderstandings still lingering around that are, for sure, bad advice today.
Paying a worker as a contractor can save your company a sizable amount of time and money. It is very tempting to go that route. As entrepreneures, we like to have control over how we do business.
When it comes to employment issues, I hate to tell you, but you don't have control.
Paying a worker as a contractor that really should be an employee can easily turn into a nightmare of wasted time and money so keep these key points in mind:
1 -- You cannot choose how to treat a worker!
- Determination is based on how the relationship actually functions. Period.
Does the payer have the right to control or direct the means or methods of how work is done (employee), or only the results (independent contractor)?
The payer doesn't actually have to use their authority to control the work.
Contracts and mutual agreements will not override how the relationship actually works in the real-world.
2 -- It doesn't matter how long they work for you!
- There is no exception for workers commonly called "day laborers."
You cannot pay a temporary worker filling-in for an employee as an independent contractor.
Time spent on the job isn't a factor. So, yes, you can have an employee for just an hour.
3 -- The worker has multiple ways to trigger a determination process. It willbe binding on your company and any other worker doing similar services!
- A worker or payer can file an IRS Form SS-8. This form asks the IRS to determine if a worker is an employee or a contractor. Their decision is binding. Their decision can't be appealed. Their decision applies to any worker doing similar services. All you can do is submit additional information for their consideration.
A worker can file an IRS Form 8919 on their income tax return. This form allows the worker to pay only the employee withholding amounts for Social Security and Medicare instead of the full Self-Employement tax rate. It also notifies the IRS the worker disagrees with how they were paid, and most times will have the above memtioned Form SS-8 attached.
A worker can file for unemployment. I have witnessed this situation several time: you pay a worker as a contractor, and everybody is happy . . . until they aren't. Now the unhappy worker tries filing for unemployment benefits. Next thing you know, the Dept. of Labor is looking into ALL your employment records for ALL your workers. You could end up paying back-wages, back-taxes, penalties, and interest for issues unrelated to the original claim. Even worse, most states have information sharing agreements with the IRS. So, even if you resolve the case with the DOL, the IRS may not be far behind.
A worker can file a worker's compensation claim. Worker classification will be yet another issue to deal with on top of an already complicated process.
Your best route is:
Be familiar with 1) the questions on Form SS-8 and 2) long-term practices in you industry BEFORE you hire a worker.
Make an honest assessment of the relationship from the start to avoid the misclassification issue altogether.
An experienced tax professional can help if you are new to this. A good offense is your best defense.
There are options if you already have misclassified workers:
- Voluntary Worker Classification Settlement Program (VCSP)
- Classification Settlement Program (CSP)
- Filing Form 4669 and Form 4670
- Section 530 relief
All options have too many qualifications and requirements to detail here. If you believe you need to use one of these options, then you should seek experienced professional advice or a tax attorney. The burden of proof is on you in the beginning so don't start any of these options uniformed.
I know this is a frustrating and intimidating situation, but keep it in perspective.
Take time to hire the right people. Workers are expensive, but unlike materials and computer programs they are real people. Real people whose efforts are helping you reach your goals and dreams.
I invite you to check out my guide, "7 Ways to Waste Time & Money in Business (and How to Stop It!)."