With summer upon us, many business owners may decide to hire students who are home from college for summer break. This may lead to the question of whether the person hired is an employee or a contractor. What you decide can make a big difference in how their pay is figured and if you are required to withhold taxes for them or not.
I am asked this question often and it is not as clear cut as you might expect. Due to the confusion of the question and the fact that people tend to misclassify workers so they do not have to pay Social Security and Medicare taxes on the worker, the IRS has made this one of their top compliance issues. Unreported or underreported employment taxes is said to make up a big chunk of the overall federal tax gap.
So how do you determine if an individual is an employee or independent contractor? The IRS states that all information that provides evidence of the degree of control and independence must be considered. In my experience, the main factor to consider is the amount of control that you, as the person hiring, have over the person providing the services. As you may have figured out, the more control the business has over the worker, the more likely they are an employee.
- Does the company control or have the right to control what the worker does and how the worker gets the job done? For instance, do you tell the person what time to be at work and what they will be doing while at work? Or do you just tell the person that provides the service what you want done and the rest is up to them to get it done and in what you consider a timely manner?
- Are the business aspects of the worker’s job controlled by the payer? For example, who provides the tools and supplies that the worker will need? Who determines how the worker is paid and if expenses will be reimbursed?
- Are there written contracts or employee-type benefits provided such as health insurance, vacation pay, a retirement plan? Will the relationship continue for an undefined length of time or is it just for a specific project? Is the work performed a key aspect of the business?
There is no magic answer or number of factors that will make a worker an employee or independent contractor, so consider how much control you have over the worker and do your best to substantiate your position if you chose independent contractor.
The IRS has suggested asking certain questions when determining status, such as must the worker follow someone else’s instructions regarding when, where, and how he or she completes the work. If so, the person is probably an employee.
If you want further guidance on this issue, contact your legal advisor or your CPA to see if they have worked with others in your industry and can offer some additional guidance. If you are still unclear, you or the worker can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS and they will officially determine the worker’s status. Beware, however, that this process can take at least six months and can bring your company and employment practices to the attention of the IRS.
Not only is this a priority with the IRS, but the Department of Labor and many of the states are getting involved in finding misclassified workers. Any information that they discover they are passing on to the IRS. If you are caught misclassifying workers with no reasonable basis, you may be liable for employment taxes for the worker as well as possible penalties and interest.
If you realize that you have been misclassifying workers and you want to correct the problem, there is a Voluntary Classification Settlement Program that provides you with an opportunity to treat the workers correctly in the future and pay a modest fine.
Taking the time to learn more on this compliance issue could make a big difference as you move forward with your hiring decisions this summer and beyond. Please contact me at 515-288-3279 if I can be of assistance.
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Located in West Des Moines, Iowa with a branch office in Winterset, Iowa, McGowen, Hurst, Clark & Smith, P.C. celebrates 65 years of extending excellent service to our clients, providing them with accounting, auditing, consulting and investment expertise.
Established in 1946, our staff has grown from 3 to 60 employees, making us large enough to provide our clients with a broad base of experience and resources, yet small enough to offer very personalized service—which we feel makes us stand apart from other CPA firms. In addition to the traditional services of Accounting, Tax Preparation, Audit and Business Consulting, MHC&S offers our clients specialized services including Estate Planning, Business Valuations, Cost Segregation Studies, Retirement Planning, QuickBooks Training, Financial Advisory Services, Fraud Detection and Deterrence, Business Succession Planning, Litigation Support and more.
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