Financial Strategies: Employees vs. Independent Contractors

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December 2, 2015

Photo: ©istock.com/Olivier Le Moal.

If you misclassify an employee as an independent contractor, you’ll face federal and state tax liabilities. Photo: ©istock.com/Olivier Le Moal.

Misclassifying an employee as an independent contractor will cost you, so classify your workers correctly.

The Internal Revenue Service (IRS) and the U.S. Department of Labor are cracking down on employers who pay workers without withholding and remitting proper employer payroll taxes. It’s important to determine whether your worker is an employee or an independent contractor because it changes the way you file taxes on him or her. Here’s what you need to know:

⦁ Reporting and tax responsibilities of an independent contractor relationship. Under this type of arrangement, if you paid an independent contractor $600 or more for services provided during the year, you need to complete and file a Form 1099-MISC and give a copy to the independent contractor by Jan. 31 of the year following payment.

⦁ Reporting and tax responsibilities of an employer/employee relationship. Under this type of arrangement, as an employer, you must withhold federal income tax, as well as Social Security and Medicare taxes, from your employee’s wages. You must also report and pay the employer portion of Social Security, Medicare, Federal Unemployment Tax, as well as other state tax and withholdings.

Based on these reporting and tax payment rules, why would anyone classify a payee as an employee? After all, the reporting and tax rules associated with an independent contractor are minimal. On the employer side, however, taxes associated with an employee could cost as much as $1.15 or more for every dollar paid to an employee.

The IRS uses specific criteria to determine the difference between an employee and an independent contractor. You have an employee, not an independent contractor, if:

⦁ you control what the worker does and how it gets done (Do you control the time and place the work gets done, among other things?);
⦁ you control the financial aspects of the relationship (Do you control the hourly rate, whether there are benefits and how expenses are reimbursed?);
⦁ you control the continuation of the project beyond a specific aspect; and
⦁ you meet other criteria.

If you misclassify an employee as an independent contractor, you’ll face federal and state tax liabilities that should have been paid had the worker been properly classified.

Additionally, a series of civil and criminal penalties and interest could accrue. These penalties include failure to file and deposit taxes, accuracy, and willful neglect of tax payments due. The penalties and interest relating to misclassification could be several times the actual taxes, as well as criminal sanctions. Although these penalties and interest are an extreme example, the amount owed can be significant.

The IRS and states might have several voluntary programs that allow a prior proper classification violator to report properly and, in many cases, reduce penalties. As an employer, if you have misclassification problems, this could be a way to minimize the potential liabilities.

Dan Gordon is a CPA in New Jersey and owns an accounting firm that caters to PMPs throughout the U.S. He facilitates several peer groups that help PMPs increase growth, profitability and accountability in their firms. Visit www.pcobookkeepers.com for information about his firm, PCO Bookkeepers. Gordon can be reached at dan@pcobookkeepers.com.

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About the Author

Dan Gordon, CPA, owns PCO Bookkeepers, an accounting and consulting firm that caters to pest management professionals throughout the United States. He can be reached at dan@pcobookkeepers.com.

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