Is your worker a 1099 or an Employee?
The holidays will be over before you know it and it will be time to issue forms 1099 and W-2. How do you know which one you should issue? Have you paid the correct payroll taxes or do you even need to be paying them? Why not claim everyone who works for you as an independent contractor and avoid paying those payroll taxes? If only it were that easy. Let’s take a step back a moment to see the difference between an independent contractor and an employee.
Independent Contractor Defined
An independent contractor is defined by the IRS as an individual for whom the payer has “the right to control or direct only the result of the work and NOT what will be done or how it will be done”. A few examples given by the IRS are doctors, lawyers, and veterinarians. The key is these individuals control the results. For these individuals your company is not responsible for paying payroll taxes. The independent contractor is responsible paying payroll and income taxes. An independent contractor receives a form 1099.
Employee Defined
An employee is defined by the IRS as an individual who performs services for you and “you can control what will be done and how it will be done”. For example, you determine when the individual works (time, day, etc), the process (order, steps reviewed, etc), and when the job is done. The key is the individual answers to you. You have control over the process. Also, for these individuals your company is responsible for withholding income tax and paying payroll taxes. An employee receives a form W-2.
Common Law Rules
The IRS uses three categories of Common Law Rules to determine whether an individual is an independent contractor or an employee. The behavioral rule addresses who has control over the job. The financial rule looks at who controls how the individual is paid, reimbursed for expenses, and who supplies the materials. The third rule is the type of relationship made between the individual performing the work and the receiver.
Based on the descriptions so far:
An individual who controls when the work is done as long as a deadline is met, is not reimbursed for business expenses, and has a contract or written agreement, would be an independent contractor. On the contrary, an individual who is required to show up at certain times to work, who is paid on a pay schedule and reimbursed for business expenses, and is receiving health benefits would be an employee.
Determining an Individual’s Status
Sounds pretty straight forward, right? What if an individual determines the time she works, receives pay monthly, and does not receive benefits? Some employers allow individuals freedom to choose when they work, some contracts require monthly payments for progress, and not all employees sign up for offered benefits. Is this individual an independent contractor or an employee? When in doubt try using the IRS FAQ page for subcontractors. If you are still not sure, use the Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. It can take up to six months for the IRS to respond, but you might find the answer just by going through the questions. Of course you can always ask your accountant.
Consequences
It is very important that individuals who perform work for you are categorized correctly. If an employee is classified in error and without basis as an independent contractor, the employer may be held liable for the employee’s employment taxes. So, if you think you have misclassified an employee or independent contractor, take action immediately. Correct the treatment of the employee or independent contractor, file the correct paper work, and talk to your accountant.
Contributed by Jamie M. Shryock, CPA