Misclassification of workers can result in major penalties and devastating fines. However, there are plenty of tools available to help you avoid misclassification errors by making sure you are classifying your employees correctly. Whether your workers are employees or independent contractors, it is important to carefully read over the classification guidelines to make sure you aren’t breaking the law.
Why does it matter?
As an employer, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid for employees. However, employers generally do not have to pay any taxes on their payments to independent contractors. Independent contractors are issued a Form 1099 from their employer, which requires the contractor to pay Social Security, Medicare and Federal income taxes.
While this might seem like a great way to save money in the short-term, it can be a very costly mistake if your business is audited by the Internal Revenue Service (IRS). The IRS estimates that millions of workers are misclassified as independent contractors. This is because misclassifying an employee that makes $43,007 a year as an independent contractor can save the employer $3,710 annually, according to a report by the Treasury Inspector General for Tax Administration.
How do I decide?
Per the IRS, an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. A few examples would be a doctor, lawyer, accountant, or a contractor.
An employee is anyone who performs services for you if you can control what will be done and how it will be done. For tips and tools to determine if a worker is an employee or independent contractor, visit the Self-Employed Individuals Tax Center on the IRS website for more information. Still unsure? You can file Form SS-8 with the IRS to officially determine the worker’s status.
You misclassified your employee(s). Now what?
If you misclassified your employee(s), there is now a way to voluntarily report your misclassification to the IRS without major penalty.
Launched in November 2017, the Voluntary Classification Settlement Program (VCSP) allows employers to do just that. To qualify, the IRS states, “the program applies to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to prospectively treat the workers as employees.” By reclassifying employees with VCSP, the taxpayers agree to:
- Treat the class of workers as employees for future tax periods.
- Pay 10 percent of the employment tax liability that would have been due on compensation for the most recent tax year.
The taxpayer also must not be liable for any interest and penalties on the amount and not be subject to an employment tax audit with respect to the worker(s) being reclassified for prior years. Although it may sound steep, the penalties are much worse if you get caught misclassifying employees before you reported it.
To apply, click here for Form 8952.
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