Authored By: Sheri Lewis, Staff Accountant, has worked at Cook Martin Poulson since November 2011. She recently received her Master of Accounting Degree and is in the process of taking the CPA exams.
A recent study conducted by the Treasury Inspector General for Tax Administration (Employers Do Not Always Follow Internal Revenue Service Worker Determination Rulings; June 14, 2013. Reference Number: 2013-30-058) called for the IRS to provide better follow-up to ensure small employers are complying with worker classification ruling. Better follow-up translates to more payroll audits. The study indicated that only 17% of employers appeared to comply with the “employee” worker classification rulings that resulted from the filing of Form SS-8 (Determination of Worker Status for Federal Employment Taxes and Income Tax Withholding). Filing a Form SS-8 requesting a “worker status” determination means the business or the worker is asking the IRS to establish if the services provided to the firm are those of an employee or an independent contractor. Receiving the determination from the IRS can be a relatively long process. The crackdown, in part, may be intended to increase tax revenue by assessing back payroll taxes and penalties.
Unfortunately, there is no clear cut way to determine whether or not a worker is an employee or an independent contractor. There are three general guidelines that outline the factors the IRS considers in making a worker classification. The guidelines are summarized as follows:
1. Degree of Control: To what extent does the employer have the ability to direct how, what, when and where the worker performs his duties?
2. Financial Opportunities: How is the worker paid? Are expenses reimbursed? Is the pay a set or regular amount? Does the worker provide his own tools and/or supplies?
3. Relationship Type: Is the position permanent or temporary? Is there a written contract? Can the worker pursue other means of obtaining income? What benefits does the employer provide?
The classification of an employee or independent contractor can had significant tax consequences for all involved. Employers must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. Employers do not have to withhold or pay any taxes on payments to independent contractors. Independent contractors must pay the full share of Social Security and Medicare taxes themselves. The study showed that an employer, on average, can save around $3,700 annually per worker with a salary of $43,000 if the worker is classified as an independent contractor. This savings potential can unduly influence some small business owners to misclassify workers as independent contractors. Additionally, employers are trying to contend with the new health care law requirement to provide health insurance if they have 50 or more employees. The Wall Street Journal reports that studies have shown that local businesses misclassify workers anywhere from 10% to more than 60% of workers as independent contractors (WSJ, Payroll Audits Put Small Employers on Edge, March 13, 2013 by Angus Loten). Ironically, due to the lack of a clear definition as to what constitutes an employee or independent contractor, many employers are unsure if they are complying with the worker classification rules until they have a payroll audit.