Through the year, a business will pay a range of people to provide services. The worker is either considered an employee and will receive a Form W2 or and independent contractor who will receive a and Form 1099. When the worker is an employee, the employer must withhold and pay these items: income taxes, Social Security taxes, Medicare taxes, and unemployment taxes. Because an independent contractor requires less tax payment, it could be tempting to treat more workers as a 1099-employee. However, the IRS actively seeks to stop intentional misclassification of workers.
Worker Classification Tests
You can read more details on the IRS website, but in general, there are three categories to consider when trying to determine how a worker should be classified. Scroll over the icons below to learn more.
Results of Misclassifying an Employee as an Independent Contrator
Misclassifying workers can result in fines and penalties at both the federal and state level. If the IRS determines you’ve misclassified an employee without a reasonable basis, you can be required to pay back wages, retroactive insurance premiums, AND additional penalties. It’s important to note that having a contract stating a worker is an independent contractor is not enough protection if one of the classification tests is unmet.
If you find yourself facing a notice saying the IRS has reclassified someone you treated as an independent contractor and have no basis, you may be able to negate some of the fees by participating in the Voluntary Classification Settlement Program (VCSP). Under this option, you must agree to treat the worker(s) as an employee(s) in the future. The benefit is that you pay a significantly smaller fee and receive audit protection for those prior years.
If you are ever unsure about how a worker should be classified, please contact your CPA. We can help you by providing an unbiased opinion of how the worker would meet the classifications.
Kim is a valued member of our CAS and tax teams. If you’re a business owner and your books are a mess – Kim can fix it. She has 25+ years of experience in nonprofit & governmental accounting and financial reporting as well as individual taxation (specifically LLCs or rental property).