Independent Contractor RulesU.S. Employee OR Contractor GuidelinesInformation on
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At the American Payroll Association's (APA) 29th Annual Congress, Steve Hodgson, CPP explained that one way the IRS audit independent contractors is through the 1099 Matching Program. IRS auditors look at individuals who have only filed one Form 1099-MISC indicating they may be an employee and not a contractor; or individuals who receive a Form 1099-MISC from the same business in more than one year.
UHY Advisors recommend that you should receive and have on file a Form W-9 Request for Taxpayer Indentication Number and Certification from each independent contractor; complete with address and TIN ... BEFORE they do any work for you. AIPB's December 12, 2011 free eNewsletter advised that in addition to sending independent contractors a 1099-MISC, you should also have each independent contractor sign Form 4699 - Statement of Payments Received ... especially if you have few or no employees. |
You will find an excellent article at the US Chamber of Commerce Small Business Nation website (www.uschambersmallbusinessnation.com) titled, The IRS's 20 Factor Analysis that lays out the independent contractor rules.
The article is somewhat hard to find on the site. I actually couldn't find how to get to it through their navigation buttons/drop down lists ... I had to do a site search. This is probably because the rules have been condensed into the three categories listed below.
Tax Compliance Your 2011 1099-MISC forms should be presented to service contractors by January 31, 2012. The contractor receives Copy B. The IRS receives Form 1096 Annual Summary and Transmittal of U.S. Information Returns AND Copy A by February 28 ... March 31 if filed electronically. To send the 1099s by email requires the explicit permission of the contractor. Source: The Bookkeeper's Notes February 14, 2011 Newsletter |
I found the article using their Toolkits search box ... type "independent contractor" in the search box and a wealth of articles pop up. Look through the list for the one titled The IRS's 20 Factor Analysis.
You will also find that the IRS have an excellent 2 page pamphlet (publication 1779) that discusses the subject. It is concise, easy to read. It is titled Independent Contractor or Employee and can be found at http://www.irs.gov/pub/irs-pdf/p1779.pdf .
This pamphlet looks at the three categories which determine whether a person is an employee or an independent:
- behavioral control;
- financial control; and
- relationship of the parties.
According to Jean Murray in What Factors Does the IRS Look at in Determining Independent Contractor Status?, the IRS does not look at any one factor but at the "whole" picture the answers to the questions create. Jean also mentions that IRS starts with the presumption that the worker is an employee.
As a general rule, the business owner does not withhold taxes when paying an independent contractor for services ... but you must report amounts paid to the IRS in Box 7 on Form 1099-MISC. The independent contractor receives a copy of the 1099 and is responsible for calculating and remitting the related self-employment taxes.
The Independent Contractor Rules
An article by Nina Kaufman, Esq. from Ask the Business Lawyer.com on How Independent Contractor Agreements Protect your Pocketbook explains one of the ways government raises revenue is by "more closely enforcing their laws, and levying penalties against those who violate them."
Tax Compliance Ezine author Wayne Davies explains in his June 18, 2009 article that there are ... 2 General Rules One - Only payment for services delivered (not merchandise goods) to your business are reported. This means personal payments to you are excluded. It also means wages to employees are not reported here. Two - Payments that total $600 or more for the reporting year AND were paid to an individual (meaning sole proprietors, independent contractors, or self-employed) are reportable on the Form 1099. Real estate agents are not considered individuals for these purposes so do not report rent paid to real estate agents. Payments to corporations are not reported unless it pertains to medical and health care payments, attorney's fees, or cash paid fish purchases. |
If you intentially misclassify a worker as an independent contractor, the IRS can reclassify the worker as an employee.
When this happens, the employer (that would be YOU) would be responsible to pay all related payroll taxes and withholdings including the employee's portion ... plus late payment penalties and interest
The IRS can also assess failing to pay employment taxes and failing to file required tax form penalties. State penalties also apply.
The employee payroll tax penalties are reduced if the worker was unintentionally misclassified. NACB Payroll Tax Update reports:
"The IRS penalty for unintentionally failing to withhold federal income tax is 1.5% of the wages paid. This assessment is doubled to 3% if the employer failed to file an information return (Form 1099-MISC) for the worker with the IRS. The IRS penalty for unintentionally not withholding the employee's share of Social Security and Medicare taxes is 20% of the employee's share of the tax. The penalty is doubled to 40% if the employer failed to file an information return for the worker with the IRS."
Nina explains that a written agreement can be a valuable weapon if/when one of these three scenarios puts YOU as a small business owner on the IRS's radar.
When completing the IRS Form 1099-MISC, always use the individual's legal name for a sole proprietorship or independent contractor. However, if the business operates under a DBA (doing business as), use the DBA name on the Form 1099. When preparing the Form 1099 for a business or partnership, use the entity's name. |
If you decide you need more information about the independent contractor rules, an additional reference to consult is the IRS Publication 15-A Employer's Supplemental Tax Guide.
If after reading the IRS information you still aren't sure how to classify your worker ... employee payroll tax help is available. Ask for an IRS ruling by filing Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Another good resource you might want to tap into for independent contractor rules is SBA.GOV (www.sba.gov)> establishing a business> hiring> independent contractors vs. employees.
They published a great article on November 7, 2011 titled, "How to Use Subcontractors to Save Money and Increase Business Agility" by Caron Beesley. You can locate it at SBA.GOV> Community Home> Community blogs> Small Business Cents. It discusses the pros and cons of working with subcontractors.
SBA.GOV (formerly Business.GOV) is the official business link to the U.S. Government.
IRS Voluntary Classification Settlement Program
On September 5, 2011, the IRS introduced a new program that allows tax relief to eligible taxpayers for reclassifying independent contractors as employees. The program is called Voluntary Classification Settlement Program (VCSP).
If you have consistently (for the past 3 years) followed the independent contractor rules by treating your workers as independent contractors AND filed all the associated Form 1099-MISC paperwork AND are not currently under audit BUT want to prospectively treat them as employees THEN file Form 8952 60 days before you begin the reclassification.
It does require you enter into an agreement with the IRS agreeing to pay 10% of the amount of employment taxes calculated with NO penalties and interest AND you will NOT be subject to an employment tax audit for the prior years.
See Announcement 2011-64 at /www.irs.gov/pub/irs-drop/a-11-64.pdf or visit the IRS website for more information.
I'll close this chat on independent contractor rules by quoting Nina's article mentioned above.
"If your company uses independent contractors to staff its work force, be very careful that you do this properly. You want to be sure to use people who can properly be classified as independent contractors and are not just part-time employees in disguise."
The U.S. Tax Information - Links
Who Should Receive an IRS Form 1099-MISC?
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