Archive for Independent Contractor
I have a client who failed to file 1099-misc for contract labor and am dealing with an examiner who denied all contract labor expenses because of a lack of IRS Form 1099-MISC back to 2007 even though an audit trail exists substantiating the expense. So the Service’s position is for the taxpayer to admit to failing to file the 1099-misc and pay the associated penalties with that failure or have the contract labor expense denied.
Generally speaking the penalty is $100 per delinquent form. However there are some exceptions… If the failure is not corrected or is corrected after August 1 of the calendar year in which the required filing date occurs, the penalty is $100 per return, up to a maximum of $1.5 million for all such failures during the calendar year [IRC Sec. 6721(a)(1)]. However, if the filer satisfies the $5 million gross receipts test for the calendar year, the maximum penalty for all such failures during the calendar year cannot exceed $500,000 [IRC Sec. 6721(d)(1)(A)].
For information returns that were required to be filed before 2011, the annual penalty is $50 per return, up to a maximum of $250,000 for all such failures during the year. The maximum penalty for a filer that satisfies the $5 million gross receipts test is reduced to $100,000.
I received an interesting call today from a small business employer who was reported to the IRS by a disgruntled past worker who claimed that he was paid as an independent contractor (and received IRS Form 1099) when in actuality he believed himself to be an employee (that should have received IRS Form W-2) for tax reporting purposes.
This prompted me to post about the new Voluntary Worker Classification Settlement Program. Having created well over 300 living wage jobs with benefits for people over the years I’ve grown to believe that most people roaming the planet today have no idea about the risks associated with that effort. The biggest risk in my opinion is associated with properly classifying workers as either employees subject to employment tax obligations or independent contractors whereby the worker is responsible for paying their own self employment tax. In the past the IRS has closed down the most well meaning business operations because improper worker classification created very large employment tax liabilities and heavily burdensome Trust Fund Recovery Penalties. The biggest risk I think is when a worker classified as an independent contractor gets injured on the job and doesn’t have his/her own insurance coverage or when a worker classified as an independent contractor becomes disgruntled and decides as a parting blow to report his/her ‘boss’ to the IRS or the US Treasury.
To alleviate that pain and mitigate some risk associated with one of thousands of decisions that job creators routinely make IRS Announcement 2011-64 gives businesses an opportunity to reclassify independent contractors as employees going forward.
IRS Form 8952 is used by businesses to apply for this reclassification opportunity. A business that applies for and is accepted into this program:
1) Receives audit protection backwards in connection with these reclassified workers,
2) Pays only 10% of the normal employer tax liability that may be due for the most recent tax year, and
3) Is not liable for interest and penalties on the amount.
In exchange the business gives IRS a six-year statute of limitation on the following three years’ employment taxes.
To be eligible:
1) The business cannot currently be under audit by IRS, the Department of Labor, or a state or local agency. If the business has previously been audited, the business has to be currently complying with the directions of that audit.
2) The business must have consistently treated the workers as independent contractors.
3) The business must have filed all Forms 1099 for the prior years.
If you are an employer you can appreciate the fact that everyone working for you it seems wants to be an independent contractor until they get injured on the job or get pissed off at you and seek relief outside of your organization. Employees and the subsequent employment tax liability they bring can be a real kick in the pants. If you have taken the risk of actually having employees then you may be keenly aware that it has become practically impossible to compete for prospective business if the competition is using improperly classified workers as independent contractors and subsequently avoiding payroll tax liabilities. It seems these days that operating margins across all industry groups are razor thin and getting undercut on bids by a competitor who is not paying employment tax creates an uneven playing field. Many, many times the difference between staying viable as a small business owner and closing up shop distills down to the employment tax liability and whether or not that liability can be paid in a timely fashion.
On the other hand if you are running fast and loose with your worker classifications and improperly classify workers as independent contractors when indeed they should be classified as employees the tax ramifications can be devastating for the responsible party. If you mis-classify workers and get audited by the IRS you can be found liable for trust fund employment taxes and the trust fund recovery penalty. These assessments are not discharged in bankruptcy and can subsequently destroy lives. I’ve seen it happen on many different occasions. The fallout is tragic particularly when good people are involved.
Now, finally, to provide relief the Internal Revenue Service is offering a new program that will allow many employers the opportunity to resolve past worker classification issues. You apply for the program by filing IRS Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before treating the workers as employees.
Employers accepted into the program will pay an amount approximately equal to just over one percent of the wages paid to the reclassified workers for the past year. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years. On the down side if it can be called that participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.
Under this new Voluntary Classification Settlement Program (VCSP), eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past, if they prospectively treat workers as employees. The VCSP is available to most for profit businesses, tax-exempt organizations and government entities that have up until now improperly classified their workers as independent contractors, and now want to correctly treat these workers as employees. To be eligible employers must:
Consistently have treated the workers in the past as non-employees,
Have filed all required Forms 1099 for the workers for the previous three years
Not currently be under audit by the IRS
Not currently be under audit by the Department of Labor or a state agency concerning the classification of these workers
For more information be sure to check out IRS Announcement 2011-64.
Employers must withhold Social Security and income taxes from employee paychecks. Conversely, independent contractors are responsible for reporting and paying their own Social Security and income taxes.
Businesses use several factors to determine how to classify its workers, including the degree of control the business has over its workers. Generally, the more control the business has over a worker, the more likely it is that the worker is an employee rather than an independent contractor.
Facts that provide evidence of the degree of control and independence fall into three categories:
Type of relationship
Behavioral control relates to whether the business has a right to direct and control how the worker performs the task for which they are hired. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that the employer has the right to control the details of how the services are performed. Such details include:
When and where to do the work?
What tools or equipment to use?
What workers to hire or to assist with the work?
Where to purchase supplies and services?
What work must be performed by a specified individual?
What order or sequence to follow?
Financial control looks at whether a worker has the ability to affect financial decisions. Does the worker have a significant investment in assets or tools? Are there unreimbursed expenses that the worker has to bear themselves? Are the worker’s services available to the public? What is the method of payment; do they get paid whether the work is done or not or do they get paid only if they finish the job? Independent contractors can realize a profit or loss on a job. Can the worker make business decisions that affect his bottom line?
Relationship of the parties looks to whether or not there is a contract between the worker and the business and how it is worded; whether the worker gets any type of benefits – vacation and sick pay, pension plan, and health or life insurance; and the permanency of the relationship such as continuing indefinitely or only for a specific project or period. Also, does the worker have his own business, which he markets to others?
If you want the IRS to determine whether a specific individual is an independent contractor or an employee, file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. 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. If you are an independent contractor and hire or subcontract work to others, you will want to review the information in this section to determine whether individuals you hire are independent contractors (subcontractors) or employees.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be -
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.