Employee v. Independent Contractor

The subject of employee v. independent contractor has received increased scrutiny recently as the Department of Labor and Internal Revenue Service, along with various state and local agencies, team up to identify and penalize businesses who misclassify employees.  This joint focus reflects an agenda to recoup decreasing governmental revenues resulting from a stagnant economy.

Last month the Department of Labor issued a press release which included the following:

“Misclassification generates substantial losses to the U.S. Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers’ compensation funds.  Misclassification also creates a competitive disadvantage for employers who comply with the law.”

A copy of the press release may be viewed here.

Why is it important to ensure your business properly classifies employees and independent contractors?

You, as the business owner, are responsible for withholding and paying employee-related taxes.  On the other hand, the independent contractor is responsible for maintainig his/her own records and paying own income and self-employment taxes.

Under Internal Revenue Code (IRC) § 3509,

When an employer erroneously treats an employee as a non-employee and does not withhold federal employment taxes, the employer is liable under IRC §3102 and IRC §3403 for the employee’s share of FICA tax and the employee’s income tax withholding. This is true even if the employer does not withhold the tax from the worker.

IF form 1099 was timely filed,

Income tax withholding is computed at the rate of 1.5% with no abatement available under IRC §3402(d).  The employer’s liability for FICA is computed at the rate of 20% of the employee’s share, plus the entire employer’s share.

IF form 1099 was not filed,

The income tax withholding rate becomes 3% with no abatement available under IRC 3402(d).  The FICA tax liability is the employer’s share plus 40% of the employee’s share.

Failure to file and failure to pay penalties may also apply.

Specific facts and circumstances regarding your business will impact considerations in properly classifying workers.  Always consult with a professional before making decisions that could impact your business.

This article is provided for information purposes only and should not be relied upon for legal or financial advice. Michelle would be happy to discuss how employee vs. independent contractor issues could impact your business. For more details, please contact Michelle directly.

IRS CIRCULAR 230 DISCLOSURE: Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact Michelle directly to discuss your specific business needs.