(909) 217-7855
Call us for a consultation
Employee misclassification as independent contractors is a major and widespread issue in the USA. While some employers misclassify their workers in error, many employers practice this intentionally to avoid paying employment taxes to their state and the federal government.
But, the IRS (Internal Revenue Service) is very strict towards this misclassification. The authority closely monitors businesses during tax audits to make sure they aren’t misclassifying their workers. It’s because the misclassification of employees and independent contractors often results in lost tax revenue.
When caught incorrectly treating your employees as independent contractors, you may end up paying unpaid taxes, hefty fines, and penalties for underpayment of taxes.
Now, you may ask, “Is there a safer alternative to cut down employment taxes while avoiding penalties and fines?”
Fortunately, yes! There is a safe harbor system that allows the safe misclassification of employees as independent workers while avoiding fines and penalties. Formally, it is called Section 530’s Safe Harbor.
In this blog, we’ll talk about the safe harbor and how to leverage it as an employer. Let’s first understand the difference between employees and independent contractors.
Employees: An employee is subject to the employer’s will and control as to job responsibilities and how to do their work.
Independent contractors: These workers provide services or goods to employers under a contract that dictates the work scope and outcomes. The key difference here is that the contractor retains control over how services or goods are delivered. They aren’t subject to the employer’s control except as outlined in the agreement. Put simply, independent contractors treat their employers like clients and often have multiple employers at the same time.
The IRS hasn’t set qualifications for determining a worker’s status as an employee vs. an independent contractor. Instead, the organization considers several factors to determine this. These factors provide evidence of the degree of control that falls into the following categories:
Behavioral: Does the employer control the worker and how s/he works?
Financial: Does the payer control all business aspects (how a worker is paid, reimbursements, who provides tools, etc.) of the worker’s job? Independent contractors realize a profit or loss from their work.
Relationship: Are there written contracts or employment perks, like pension, insurance, etc.?
Being an employer, you’ve to weigh all these factors in determining whether a worker is an employee or an independent contractor.
Benefits available to employees are often treated with special tax programs that are not applicable to independent contractors. In contrast, contractors get benefits like tax deductions and individual qualified plans, which are inaccessible to employees.
So, employers misclassify an employee as an independent contractor in order to avoid paying employment taxes.
If you practice the misclassification of employees as independent contractors, you can avoid retroactive fines and punishment by qualifying for Section 530 protection. This federal law lets you:
As per the section, the IRS won’t be able to retroactively reclassify your independent contractors as employees even when contractors are W-2 employees under common law.
It takes just three easy steps:
Step 1: You never treated your independent contractors as employees.
You’ll not qualify for safe harbor protection if you convert W-2 employees into independent contractors while they continue doing similar jobs.
Step 2: Treat workers as independent contractors on tax returns.
Here, you’ve to file Form 1099 to the IRS properly and timely. Courts and the IRS should find consistent treatment as independent contractors on your tax returns.
Step 3: Reasonable basis for treating individual workers as independent contractors.
Things you can use for a reasonable basis are:
When you recruit independent contractors, make sure you document your compliance with Section 530. You’ve to do this periodically to stay compliant.
Please note that Section 530 is exacting. So, it’s best to engage a tax professional for tax audits and to establish and maintain compliance with Section 530.
We will happily offer you a free consultation to determine how we can best serve you.
Contact Us Today
