Classification
Classification of employees and contractors are crucial from the beginning and can lead to serious tax problems in the future if not done correctly. Most businesses hire employees and from time to time depending on the nature of your business, may need to hire an outside expert to help with special projects.
As the business owner or human resources professional, you are faced with classifying your workforce properly. If audited, your business may face expensive penalties and fines by federal or state auditors. Thankfully, the IRS has guidelines that can help you to determine the proper classification of these individuals. Using Form SS-8 is a great tool to assist you to determine whether you are reporting all the required income and mandatory tax deductions such as federal income tax withholding, Social Security, and Medicare tax withheld and reported on Form W-2 at the end of the year. Contractor’s disbursements are reported on Form 1099-Misc.
Common Law Rules
You will need to become familiar with these three common law rule facts before you can determine the classification. These facts provide evidence of the degree of control and independence you exercise within the scope of your business relationship.
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Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
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Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
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Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Misclassification of Employees
If you misclassify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. The payment of the taxes maybe carried back to the beginning of the business relationship. Also, at the time of hire, if the individual understood the relationship was to be that they were to be hired as a W2 employee and at year end they realized not taxes were withheld, that will be cause for them the become disgruntled and initiate the contact with the labor board or other authorities. Either way, there is some explaining that needs to be done.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.
It is financially difficult for any business to meet their respective payroll obligations every pay period, yet failing to properly classify your hired help will lead you to more expensive exposure that can be avoided from the outset.