INCOME TAX PREPARATION

Suppose you hire several "outsiders" to do some inside work. Are they employees or independent contractors. It can make a big tax difference. The IRS is cautioning small business owners about misclassifications. It recently issues  a reminder about the basic guidelines for determining the employment status of workers. 


This is not small potatoes. If the IRS discovers an error, it will assess back federal employment taxes for the years in question, plus interest and penalties. If a worker is treated as an employee, the business must withhold federal income tax and the employee's share of Social Security and Medicare taxes from his or her wages. In addition, the business has to pay it share of Social Security and Medicare taxes  plus federeal unemployment tax . Finally, your small business is required to isssue a Form w-2 to the employee, providing the relevant information. 


On the other hand, if a worker qualifies as an independent contractor, your business is not responsible for federal income tax withholding and does not owe Social Security. Medicare, or FUTA taxes on the worker's wage/ What's more, your business does not have to provide costly fringe benefits, such as health insurance, 401k plans and group term life insurance to those workers. For these reasons  , this setup is generally preferable to small business owners.


The IRS emphasizes two key factors 


1) Control: The relationship between a worker and a business is important. If the business controls what work is accomplished and directs how it is done, it exerts behavioral control. If the business directs or controls financial and certain relevant aspects of a workers job, excercises financial control . This includes the follow:

  • The extent of the worker's investment in the facilities or tools used in performing services
  • The extent to which the worker makes his or her services available to the relevant market
  • How the business pays the worker ( by the job, or by the hour, day week or month)
  • The extent to which the worker can realize a profit or incur a loss


​2) Relationship: how the employer and worker perceive their relationship is also significant in determining the worker status. Some of the key issues to think about include the following:

  • Written contracts describing the relationship the parties intended to create
  • Whether the business provides the worker with employee type benefits such as insurance, a pension plan, vacation or sick pay
  • The permanence fo the relationship
  • The extent to which services performed by the worker are a key aspect of the regular business of the company
  • The extent to which the worker has unreimbursed business expenses

Finally, the IRS reminds employers that it can help determine the status of their workers by fusing Form ss-8. 

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MBA Taxation

Daniel Cullinane CPA

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