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Distinguishing between Independent Contractors or Employees; Don’t Let Mislabeling Cost You

Employers have several tax obligations related to their employees. They are expected to withhold income taxes and social security and Medicare taxes from their employees’ pay in addition to paying unemployment tax on their wages. On the other hand, employers have no tax obligations on payments they make to independent contractors. Whether or not you use the services of independent contractors or employees depends entirely upon your business needs, but it is critical that you know the difference between these two very different types of workers.

Employers have several tax obligations related to their employees. They are expected to withhold income taxes and social security and Medicare taxes from their employees’ pay in addition to paying unemployment tax on their wages. On the other hand, employers have no tax obligations on payments they make to independent contractors. Whether or not you use the services of independent contractors or employees depends entirely upon your business needs, but it is critical that you know the difference between these two very different types of workers.

Basically, under common law rule, an independent contractor is someone who provides service to your business and whose method of working you cannot control. You only have the right to control or direct the result of his or her work. According to the IRS, you are working with an independent contractor when you cannot control “what will be done and how it will be done.” Anyone who performs a service for your business is an employee, if you can control what will be done and how it will be done.

With the many different kinds of trades, services, and business arrangements available across the many industries in our market, there are some workers who just do not seem to fit perfectly into any one category of either employee or independent contractor.

To complicate the matter even further, certain kinds of independent contractors may also be considered statutory employees for tax purposes. An example of this kind of service provider is a life insurance sales agent who works full-time and who chooses to sell life insurance or annuity contracts for one particular life insurance company. In the same vein, certain workers may be considered statutory non-employees.

 

Determining the Type of Individuals Performing Services:

Independent Contractor – A self-employed individual who performs a service or creates a product for a business, but the business cannot control or direct how the work is done is an independent contractor. Typically doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers and auctioneers fall into this category.

 

Employee (common-law employee) –Anyone who performs services for a business by controlling what will be done and how it will be done.

 

Statutory Employee – Even if workers are independent contractors under the common law rules, such workers may still be treated as employees by statute for certain employment tax purposes.  If they fall under one of four scenarios and meet three conditions under the Social Security and Medicare taxes, then you may still need to treat them as an employee for tax purposes.

  • Drivers distributing beverages (other than milk) or meat, vegetables, fruit, or bakery products; or who pick up or deliver laundry or dry cleaning, if the driver is your agent or is paid on commission.
  • A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.
  • An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.
  • A full-time traveling or city salesperson that works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the byer’s business operation. The work performed for you must be the salesperson’s principal business activity.

 

Social Security and Medicare Taxes

Employers should withhold Social Security and Medicare taxes from the wages of a statutory employee if all three of the following conditions apply:

  1. The service contract states or implies that substantially all the services are to be performed personally by them.
  2. They do not have a substantial investment in the equipment and property used to perform the services.
  3. The services are performed on a continuing basis for the same payer.

 

Statutory Nonemployee: Believe it or not, there are three categories of statutory nonemployees, too: direct sellers, licensed real estate agents and certain companion sitters.  The first two categories, direct sellers and licensed real estate agents are treated as self-employed for all federal tax purposes including income and employment taxes, if:

  • Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and
  • Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.

 

Conversely, companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes.

 

Government Worker: In most cases, individuals who serve as public officials are government employees.  In this situation, the individual is an employee of the government and the government entity is responsible for withholding and paying Federal income tax, social security, and Medicare taxes.

 

Still confused?

There are generally three common law categories that can be used to help you distinguish the type of business relationship you have with your worker and whether or not he or she is an independent contractor or an employee. They are behavioral, financial, and type of relationship – and they highlight the levels of control and independence in the business relationship.

Behavioral – Consider whether you have the right to control what your worker does and how he or she gets the job done.

Financial – Do you control all the business aspects of the job, such as supplying tools and materials, or deciding how the worker is paid, and whether or not expenses are reimbursed?

Type of relationship – Are there written contracts or benefits established, such as a pension plan, leave pay, or insurance? Is it an ongoing relationship that facilitates a key service to the business?

While the IRS provides extensive guidance on determining a worker’s status, there is no strict black and white, easy-delineation; you are encouraged to look at the entire business relationship to come to an understanding. If after you have looked into the situation thoroughly and you still have doubts, you can get help from the IRS by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will look over the data and officially identify the worker’s status for you.

If you’re still unsure, it may be time to solicit the assistance of a small business advisor. Visit the Find an Accountant tab to locate a small business accountant, enrolled agent or tax advisor near you.

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations.

 

To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

 

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.

Taxpayers Encouraged to Get Paycheck Check Up

If it has been a while since you have looked at your pay stub or reviewed your tax withholding, stop what you’re doing and make a point to do it today.  Circumstances change and with the new Tax Cuts and Job Act (TCJA) in December 2017, there are even more pressing reasons to perform a quick paycheck review. According to the IRS, employers should encourage employees to use the new IRS withholding calculator at www.IRS.gov/w4app to make sure that their federal income tax withholding is in line with the changes made by TCIA.  The danger is that with the changes, employees may be unknowingly withholding too much or too little and will end up owing much more than they planned for 2018 income taxes.  The IRS has also released a set of special plain language Tax Reform Tax Tips, a You Tube video series and other special efforts to help taxpayers better understand the implications of the law.

Among the groups who should check their withholding are:

  • Two-income families.
  • People working two or more jobs or who only work for part of the year.
  • People with children who claim credits such as the Child Tax Credit.
  • People with older dependents, including children age 17 or older.
  • People who itemized deductions in 2017.
  • People with high income and more complex tax returns.
  • People with large tax refunds or large tax bills for 2017.

 

How does the calculator work?

The calculator asks questions about employment history including even partial year or short employment periods. If the taxpayer has more than one part-year job, the withholding calculator can account for this as well, whereas the paper W-4 worksheets do not distinguish between part and full year jobs.

 

Two-income families, multiple job holders

For individuals with more complex tax profiles, such as two or more incomes or multiple jobs, the risks of being under withheld is even greater. Users can even use the withholding calculator to enter income from multiple job or from two employed spouses. It can also ensure that taxpayers apply their 2018 tax deductions, adjustments and credits once rather than multiple times with different employers.

 

Plan for Different Standard Deductions

The TCJA nearly doubled standard deductions and changed several of the itemized deductions for 2018. Individuals who previously itemized deductions on their federal income tax filing may not be able itemize, but may find that they can take the standard deduction, further affecting how much tax payers may need to have withheld.  “With all of the changes this year, it is especially important for taxpayers to fully understand the financial impact on their federal withholding rather than waiting,” says Dave Flynn, owner of Flynn Accounting Solutions in Stoneham, MA. “There’s no reason to have an expensive surprise in next April’s tax filing, when a simple check at the IRS.gov website can help taxpayers correct their withholding amounts now,” he continues.

To make a change to the withholding now, taxpayers will need to complete a new Form W-4 Employee’s Withholding Allowance Certificate to their employer. Waiting until later in the year, means that there will be fewer pay periods remaining to make any necessary correction deductions before year end – which could seriously impact on each paycheck.  Taxpayers with even more complicated situations may want to reach out for guidance.

 

To learn more about tax planning, talk with a Professional Small Business Advisor by clicking Find an Accountant on this page.

 

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations.

 

To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

 

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.

 

 

 

IRS Tax Notices Explained

You filed your taxes, processed all of your W-2s and 1099-Cs and think your federal reporting is in great shape – until you receive the dreaded IRS tax letter. Your stomach knots, your mouth goes dry and suddenly a clammy panic takes hold. “Be calm!” says Appletree Business Services owner Steven Feinberg, CPA.  “There are all kinds of notices and letters the IRS can send, so take a deep breath and review the letter carefully,” he continues.  Often there are ample instructions on what the IRS needs a taxpayer to do.  In the event you have questions, you can always reach out to the IRS directly or contact your local Professional Small Business Advisor.

 

The IRS sends notices and letters for a variety of reasons. The most common are:

  • There’s a balance due.
  • The taxpayer is due a larger or smaller refund that what was originally filed.
  • There is missing or unreported income from another source.
  • The IRS has a question regarding the tax return.
  • Random selection – that’s right, each year the IRS randomly selects taxpayer reviews based on a statistical algorithm.
  • The IRS needs to validate the taxpayer’s identity – i.e. the SSN doesn’t match the name.
  • The IRS made a correction or change to the return.
  • The IRS is notifying of a delay in the return.
  • Final notice of intent to levy and notice of your right to a hearing.

If your correspondence indicates that a response is requested, it is in your best interest to respond within the given time frame to help reduce or eliminate additional penalties, or preserve your right to appeal if you don’t agree with their findings.  If you are required to respond or take action in the letter, you will want to include the CP or LTR number found on either the top or bottom right-hand corner of the correspondence. Be sure to take down the agent’s ID number, name and the date and time you spoke.

Let’s review the most common types of IRS letters and what they might mean for your situation.

CP2000 Notice – issued when the income and/or payment information doesn’t match information reported on the tax return.

CP11 – This letter is sent when there are changes to a tax return or a balance due.  The IRS has made a change to the tax return and there is now a balance due.

CP12 Notice – This notice is issued when the IRS corrects one or more mistakes on a taxpayer’s return and a payment has become an overpayment or an original overpayment amount has changed.

CP-90 – Final Notice of Intent to Levy and Notice of Your Right to a Hearing – This is the only notice that permits the IRS to take action against a taxpayer. If you have received this notice, you have already received several other communications from the IRS. Once this notice is delivered, you have 30-days before the IRS is legally entitled to take action. You can request a meeting with an IRS appeals officer or start collection due process.

If you are required to pay additional taxes to the IRS and you agree with their findings, you still have a few options available to you:

  • Pay the amount due in its entirety
  • Pay a portion of what you owe
  • Apply for an Online Payment Agreement or Offer in Compromise.

A note about IRS letters: Beware of suspicious notices or letters that were designed to look like they came from the IRS. If you are suspicious, you can call the IRS hotline at 1-800-829-1040. Remember that the IRS will never ask taxpayers for personal information via email or social media sites.

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations.

To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.