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2001 On-line Tax Planning Employee v. Independent Contractor StatusBusiness owners and managers must frequently decide whether their laborers are properly categorized as employees of their organization or independent contractors. The treatment of the payments to a laborer is significantly different between these two classifications. Employers are required to withhold various payroll taxes from employees, but have no such obligations with respect to independent contractors. Moreover, employers must pay Social Security, Medicare and unemployment taxes on behalf of their employees, but not their independent contractors. Often, business owners and managers want to avoid these taxes by classifying their laborers as independent contractors under the mistaken belief that the only consequence of the IRS overturning that classification is the cost of the employer's portion of the tax and maybe a little interest on the deficiency. That assumption can be an expensive miscalculation. Whether a laborer is properly
treated as an employee is primarily a question of the degree of control
that the employer exercises over the laborer's performance of his
duties. The body of law that has developed around this question is
derived from old English common law. The answer is subjective in
nature as it is dependent upon the facts and circumstances in each
case. However, certain factors are generally accepted by the IRS and
the courts to be of relevance in most cases. These factors include
whether the employer provides training, tools and assistants to the
laborer Of course, the IRS is very familiar with this issue. They also know that the likelihood of their receipt of Social Security, Medicare and income taxes owing with respect to the payments to the laborer is much greater if these taxes are withheld and paid at the source rather than voluntarily reported and paid by the laborer when he files his income tax return (believe it or not, some people don't report all of their income!). Consequently, the IRS has a vested interest in this classification issue, and their prejudice is to classify laborers as employees as often as possible. If an employer fails to properly classify a laborer as an employee and the IRS prevails in its reclassification, the employer could be held responsible for not only the employer's portion of the Social Security and Medicare taxes not remitted, but also for the employee's share of these taxes, plus the income tax that should have been withheld, plus interest on the deficiency, plus various penalties. The following example illustrates the economic exposure to the employer. Example: In calendar year 2001, Xcorp pays $80,400.00 to IC, an individual, for services he provides to Xcorp. Xcorp treats IC as an independent contractor and does not withhold or pay any payroll taxes with respect to the $80,400.00. The IRS challenges the classification and prevails. The IRS computes the following deficiency:
Alternatively, if Xcorp had treated IC as an employee, its only cost would have been the employer's portion of Social Security and Medicare, which totaled $6,150.60. Obviously, the exposure of improperly classifying a laborer can be significant. Not all individuals who
provide services for businesses are employees. Independent
contractor treatment is the correct classification in many
situations. However, if you have any doubt as to the proper
treatment in a specific situation, you should contact us and let us help
you evaluate the case. The stakes may be greater than you think.
Bucheri McCarty & Metz LLP
Telephone: (765) 236-2300 |
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or whether the laborer supplies these himself; whether the laborer
provides the same services for others and holds himself out to the public
as an independent provider of such services; whether the employer controls
the hours the laborer works and the means by which he accomplishes the
tasks for which he is being paid; and several other factors. The
preponderance of the evidence in each case will control the
classification.