What You Need to Know about Classifying Workers for Taxes
As an employer, it is extremely important to properly classify workers. Worker classification is commonly overlooked by business taxpayers, yet it can have significant tax implications. It’s extremely important to properly classify workers as either “employees” or “independent contractors” to ensure you are complying with the correct tax laws. The way you classify your workers will determine how you report wages, pay payroll taxes, file reporting documentation and more.
Determine Your Situation
Before you can properly classify workers, you must first identify your situation. If you are a business owner or independent contractor who provides services to other businesses, you are considered to be self-employed. If you are a business owner and you hire or contract with individuals to provide services to your business, you must determine the role of these individuals. For tax purposes, you must classify that these people are independent contractors, employees, statutory employees or statutory non-employees.
Employees versus Contractors
After you understand you own situation, you can determine how to classify the individuals who provide services to your business. As previously mentioned, the person who performs services for your business can be an independent contractor, employee, statutory employee or statutory non-employee.
The first of these is an independent contractor. An independent contractor is a person who contracts to do work for another person according to their own processes and methods. If you hire an independent contractor, you only have the right to control the result of the work as it specified in the agreement between you and the contractor. You do not have control over what will be done or how it will be done. Typically, the working relationship between an employer and a contract employee is flexible and provides benefits to each party.
In regards to tax obligations, independent contractors are subject to Self-Employment taxes. Self-employed contractors are responsible for all taxes. One of the benefits for independent contractors is the ability to deduct business expenses from their federal income tax. If you hire an independent contractor, they are responsible for paying their estimated taxes owed quarterly.
The second type of person who performs services for your business is an employee. An employee, under common-law rules, is anyone who performs services for you that you are able to control. If you control what is done and how it is done, you are likely dealing with an employee. Even if you give that individual freedom of action, you are controlling the details of how the service is performed, making them an employee. When you hire employees, you are responsible for withholding a portion of the employees’ compensation and paying Social Security and Medicare taxes under the Federal Insurance Contributions Act (FICA). As an employer, you withhold these taxes from each paycheck.
Another type of employee is a statutory employee. According to the IRS, “If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet three conditions described under Social Security and Medicare taxes.”
The four categories include being a driver who is an agent or paid on commission, a full-time life insurance sales agent, whose primary role is to sell life insurance or annuities, an individual who works at home on materials or goods that you provide and are returned to you, and a full-time traveling or city salesperson who works on your behalf. You are responsible for withholding Social Security and Medicare taxes from statutory employees if the contract states all services are performed by them personally, they do not have a substantial investment in the equipment or property used to perform the task and if the service is performed on a consistent basis for the same payer.
The final type of individual you can hire in a statutory nonemployee. Statutory nonemployees fall within three categories: direct sellers, licensed real estate agents and certain companion sitters. For Federal tax purposes, direct sellers and licensed real estate agents are considered self-employed including income and employment taxes if a substantial amount of their payments are directly related to sales or other output rather than hours worked. Additionally, their services must be performed under written contract, which states that they will not be treated as employees for Federal tax purposes. If a companion sitter is not part of a larger organization, they are generally treated as self-employed as well.
Why It Matters
Properly classifying your employees dictates how you report wages, pay payroll taxes and file reporting documents. As previously mentioned, when you’re an employer, you are responsible for paying a portion of your employees’ taxes. You are also responsible for paying unemployment insurance on each employee. In addition to this, when you have employees, you are responsible for abiding by minimum hourly wages, overtime time, rest break laws, harassment and discrimination and Family Medical Leave. The responsibilities vary greatly between independent contractors and employees and misclassification can lead to serious tax implications.
If you’re unsure how to classify your employees, let Landmark Tax Group help. We can assist you in properly classifying your workers to make sure you are in compliance with current employment requirements. If your situation is complex and proper classification is unclear, we can go straight to the IRS to issue an official classification determination. If you have improperly classified employees and received a penalty from the IRS, we can prepare and submit a penalty and interest abatement request on your behalf. We will represent your interests in front of all of the appropriate IRS divisions.
As former IRS Auditors and IRS Collectors , we understand how the IRS works and how to protect you and your assets. Each situation is unique, so we offer free consultations with former IRS agents to discuss your individual needs. For assistance with worker classification, or another tax matter, contact us today at 1-714-382-6780 for a FREE and CONFIDENTIAL consultation.