The IRS remains focused on an issue that doesn’t seem to be going away: the misclassification of workers as independent contractors rather than employees. Recently, the IRS issued still another fact sheet “reminding” employers about the importance of correctly classifying workers for purposes of federal employment taxes (FS-2017-9). Generally, employers must withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to employees. They are lifted of these obligations entirely for independent contractors, with usually the only IRS-related responsibility being information reporting on amounts of $600 or more paid to a contractor.
Weighing the factors
Whether a worker is an employee or an independent contractor depends on a number of considerations that fall into three categories: behavioral control, financial control and the type of relationship between the worker and the service recipient. Within these categories, the IRS has identified 20 factors that can be used to determine whether an individual is an independent contractor or effectively an “employee.”
The determination of independent contractor versus employee status is based on all of the facts and circumstances surrounding the relationship. None of the identified factors is determinative. In addition, not all factors are present in all employee or independent contractor relationships. Frequently, the relationship of a worker is clear cut using these factors; but sometimes a worker can fall into a gray area.
The Form SS-8 route
An employer who is unsure of how to classify its workers can file a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. There is no fee for requesting a worker classification determination. Because worker classification has become such a “hot” audit trigger, many employers opt for the Form SS-8 route, particularly because penalties on top of back employment taxes can result from a classification misstep.
After emphasizing in its latest Fact Sheet that employee misclassification as independent contractors exposes the employer to employment tax liability, the IRS also highlighted two ways to escape or ameliorate liability, even for an after-the-fact classification: “Section 530 relief” and relief under the Voluntary Classification Settlement Program.
Section 530 relief: An employer that has a reasonable basis for classifying its workers as independent contractors may be entitled to special relief under section 530 of the Revenue Act of 1978. “Section 530 relief” protects taxpayers who have consistently treated workers as independent contractors and have a reasonable basis for doing so. The rule covers workers who are common law employees, but it does not cover certain third-party-arranged technical service workers.
A reasonable basis for classification for purposes of Section 530 relief generally includes an employer’s treatment of the individual based on any of the following:
- judicial precedent, published rulings, technical advice to the employer or a letter ruling to the employer;
- a past examination of the taxpayer by the IRS in which there was no assessment attributable to the treatment for employment tax purposes of individuals holding positions substantially similar to the position held by this individual; or
- long-standing recognized practice of a significant segment of the industry in which the individual was engaged.
Voluntary Classification Settlement Program. Entry into the Voluntary Classification Settlement Program (VSCP) can provide an opportunity to reclassify workers as employees for future tax periods, with partial relief from federal employment taxes. Under the program, the employer:
- Agrees to prospectively treat the class of workers as employees for future tax periods;
- Will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under reduced rates;
- Will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years; and
- Will not be liable for any interest or penalties on the liability.
Under the VCSP, an employer may reclassify some or all of their workers. Once reclassified, all workers in the same class must be treated as employees for employment tax purposes.
The IRS also makes it clear in its latest Fact Sheet on employee misclassification that action on its part may take place not only based on an employer-based initiative; workers can also have indirect input on whether an audit will take place. “Workers who believe an employer improperly classified them as independent contractors may use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee’s share of uncollected social security and Medicare taxes,” the IRS Fact Sheet concludes.
If you have any concerns surrounding possible worker misclassification within your business, please feel free to contact our office for a more targeted discussion.