Nonprofit Finance & Accounting Tip: Employee vs. Contractor Classification
Recently the IRS has increased its efforts to identify workers who are misclassified as independent contractors. These efforts are aimed in part at increasing tax revenue.
According to an article published in The Wall Street Journal on March 13, 2013, titled, “Payroll Audits Put Small Employers on Edge” by Angus Loten and Emily Maltby,
“Since September 2011, the government has collected $9.5 million in back wages for more than 11,400 workers who were misclassified as independent contractors by their employers, the Labor Department says.”
Generally, an employer must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee, but does not have to withhold or pay any taxes on payments to independent contractors.
As the IRS continues to surprise small businesses and nonprofits with payroll audits, it is important to understand the difference between an independent contractor and an employee. Fortunately, the IRS provides guidance on how to determine a worker’s status:
- Behavioral. Does the company control of 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 controller by the payer? (these includes things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- 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?
It is important to note that each factor is subject to interpretation. Case law on the subject has a history of inconsistent outcomes, making it hard for a business to benchmark a particular situation. According to the IRS, the keys are to look at the entire relationship, consider the degree or extend of the right to direct and control and to document each of the factors used in coming up with the determination.
If an employer is unclear whether a worker is an employee or an independent contractor, he can file IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will review the information provided on the Form and officially determine the worker’s status.
If an employer believes he has misclassified a worker, the IRS is offering a Voluntary Worker Classification Settlement Program that provides eligible employers relief from past payroll taxes. For more information on this program, please view the following IRS News Release, IRS Expands Voluntary Worker Classification Settlement Program.
Melissa Stockberger, Jitasa Accounting Specialist Manager, CPA