When it comes to tax obligations, there is a difference between independent contractors and employees. The Internal Revenue Service (IRS) explains that, in general, a worker is an independent contractor when they have independence over their work. When the payer can control or direct the worker, the relationship is that of an employer/employee.
If the relationship is questioned, the agency will generally review three categories: behavioral, financial and relationship. Behavioral control will involve a review of the instructions given and the job evaluation structure. When the evaluation focuses more on the process of getting the work done, the IRS will consider the relationship of an employee/employer. If it only focuses on the final product, the IRS will consider the worker a contractor. When the business controls more than just the cost of the final product, the financial control would indicate an employee/employer relationship. The IRS will also consider the relationship that of an employer/employee if it includes benefits like insurance or permanency that appears to continue indefinitely.
Why does the distinction matter?
The designation will impact the business’ and workers’ tax obligations. The distinction can come with benefits and risks for independent contractors. Three examples include:
- Benefit: Availability of business expense deductions. Those who are designated as an independent contractor can deduct business expenses. The new tax law essentially removed this deduction for employees.
- Risk: Need to meet social security and Medicare expenses. Employees and employers share the responsibility for paying into the social security and Medicare programs. Independent contractors are 100% accountable for paying these taxes.
- Benefit: Business income deduction. Independent contractors can also take advantage of the 20% qualified business income deduction on their federal tax returns.
Another risk that will directly impact employers: the failure to correctly classify a worker as an employee can result in serious tax consequences. Employers have attempted to work around these obligations, and the IRS notices. For example, the agency recently scrutinized the actions of professional employer organizations or employee leasing companies. The agency has stated these businesses are treating independent workers as employees and challenged their worker classification.
The agency’s challenge may signal an oncoming increase in the agency’s focus on worker classification. As such, businesses are wise to review their practices. The attorneys at Goldburd McCone are experienced in cooperate and tax law matters. They can review your business plan and discuss various options for compliance, as needed.