Whether you are an employer hiring independent contractors, or you are an independent contractor working for a business, you need to understand the tax planning implications of a worker classified as an employee (receives a W-2) or an independent contractor (receives a Form 1099-MISC).
Employers often mistakenly believe that they determine how a worker is to be classified. Some employers realizing that there are incentives to classify their workers as independent contractors will ignore the common law tests of determining whether a worker is an employee or a contractor. The tests tend to look at who controls the worker. If the employer controls the worker, the worker will be classified as an employee. If the worker controls his or her duties, the worker is an independent contractor. For further IRS tests, see Rev. Rul. 87-41.
Employers who ignore the rules do so to avoid paying employment taxes and costly employee benefits, or comply with a myriad of employer rules. One of those myriad of employer rules that may further motivate employers to improperly classify workers as independent contractors is the Patient Protection and Affordable Care Act. Businesses with 50 or more employees will be required to provide health insurance to employees to avoid a penalty. That penalty could be as high as $3,000 per worker.
In our Exton PA CPA office, we often hear business owners confidently (and erroneously) state that it is not an issue because the worker has signed a contract as an independent contractor. Unfortunately for the business owner, the IRS looks at its tests as to who controls the worker and will only consider the contract if the IRS is uncertain as to who controls the worker. Employers sometimes hire a worker as an independent contractor for a probationary period. If the worker does well, then the employer hires the worker as an employee. If audited by the IRS or Dept. of Labor and it is found that the worker performed the same duties during the probationary period and when hired as an employee, the auditor is likely to find that the worker was an employee during the probationary period. We have also seen that some employers will only hire workers who have formed a limited liability company (LLC) and have obtained a separate employer identification number (EIN). We believe that these employers are hoping that the LLC and EIN will be less detectable under an IRS or DOL audit than when the employer pays an individual with a social security number.
What does an employer have to lose by misclassifying a worker? The employer could be found liable for the unpaid employment taxes (including the employee share), late payment penalties and interest for not remitting the payroll taxes required to be withheld when paid to the worker, and benefits due the misclassified worker (e.g., health care, retirement funds).
Note: Because each business has unique factors that need to be examined when determining its tax situation, we invite you to call 610-594-2601 today to make an appointment to discuss your situation. You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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