There are many tax provisions that apply to small business owners but determining how to classify people that are working for a small business is very important. It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors.
Generally, employers must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. They do not generally have to withhold or pay any tax taxes on payments to independent contractors.
Determining Whether the Individuals Providing Services are Employees or Comtractors
In determining whether the person providing services is an employee or independent contractor, all information that provides evidence of the degree of control and independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these
include things like how worker is paid, whether expenses are reimbursed, who provides
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct or control, and finally, to document each of the factors used in coming up with the determination.
If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.
Be aware that it can take at least six monts to get a determination, but a business that continually hires the same type of workers to perform particular services may want to consider filing the Form SS-8.
Employment Tax Obligations
Once a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying the associated taxes.
- This link to IRS.gov will give the forms and taxes that are applicable to independent contractors: Forms and associated taxes for independent contractors
- This link to IRS.gov will give the forms and taxes that are applicable to employees: Forms and associated taxes for employees
Consequences of Treating an Employee as an Independent Contractor
If an employer classifies an employee as an independent contractor and has no reasonable basis for doing so, they may be liable for employment taxes for that worker.
If the employer have a reasonable basis for not treating a worker as an employee, they may be relieved from having to pay employment taxes for that worker. To get this relief, the employer must file all required federal information returns on a basis consistent with the treatment of the worker.
Voluntary Classiification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employee for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participte in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.