July 2008
Employees vs. Independent Contractors –
Tax concerns
July 2008
In 1982, Section 3509 of the Internal Revenue Code
was enacted. The primary purpose of the law was to
relieve the “…tax burdens that may arise when a worker who
has been treated as an independent contractor is
reclassified as an employee.”
Our purpose here is to explain the tax consequences of
misclassifying because we have reason to believe that the
IRS may soon implement a special program designed to ensure
that employees are not misclassified as independent
contractors.
Depending on the facts and circumstances, the rules
impose various levels of obligations on employers who
misclassify employees. The following provides
examples.
a) If an employer unintentionally fails
to deduct and withhold taxes from an employee by
misclassifying them as an independent contractor, the
employer's liability might be equal to 1.5% of wages paid
for federal withholding and 20% of the employee's portion of
FICA under Section 3509.
b) If an employer unintentionally fails to deduct and
withhold taxes from an employee by misclassifying them as an
independent contractor AND disregards and does not meet
reporting requirements the employer’s liability is may be
increased to 3% of wages for federal withholding and 40% of
the employee’s portion of FICA, again under Section 3509.
c) If an employer intentionally misclassifies an
employee, Section 3509 does not apply. Instead the IRS
can subject the employer to the full amount of income taxes
that should have been withheld, the full amount of employer
and employee shares for of FICA, and as well as interest and
penalties.
On June 20, 2008, the IRS Chief Counsel Advice issued
a memorandum that clarified when employers can apply the
rates and provisions found in Section 3509 to mitigate harsh
consequences under the law. The memorandum concludes that
Section 3509 may be utilized to determine the employer’s
liability when the employer has learned of the
misclassification after receiving a determination letter
from the IRS, meets the requirements of the Section 3509, or
seeks to correct deficiencies for of prior calendar years.
The 2008 memorandum offered nothing new except to simply
clarify current law.
Clearly, to avoid exposure it is advisable to classify
workers correctly from the start. The following are some of
the characteristics that can assist in the determination of
the proper classification. The following is not all
inclusive:
With regard to employees,
generally the employer will control how and with what resources the service is to be performed. Employees often have fixed hours of work, are
paid according to a set salary, and can be fired or quit at
any time.
Independent contractors,
on the other hand, often determine for themselves how work
is performed and provide their own equipment or supplies.
Often, independent contractors set their own hours of work,
are paid by the job, and may typically work for more than
one business.
The IRS has published additional information in its
guidance on worker classification. The 160-page guidance is
essentially training material used by examiners.
If you have questions, or if you would like a copy of the
IRS training material, please contact Vincent Ruocco, LLC,
CPA at 203.932.2931.
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