How Does Worker Classification Affect Federal Employment Taxes?

 Posted on May 18, 2022 in Taxation Law

Businesses will need to address multiple types of tax issues, including paying all required employment taxes. One of the key issues that can affect these taxes involves how workers are classified. Different requirements apply for employees and independent contractors, and by ensuring that workers are properly classified, an employer can avoid potential penalties or other problems 

Understanding Federal Tax Requirements for Employees and Independent Contractors

Employees who work directly for an employer have certain rights, including the right to receive a minimum wage and overtime pay. They can also receive certain benefits, including workers’ compensation for work-related injuries or illnesses, unemployment insurance, and other benefits provided by an employer, such as sick pay, vacation or personal days, and the ability to participate in a health insurance plan or an employer-sponsored retirement savings account.

For workers who are classified as employees, an employer is required to withhold employment taxes from their wages, including federal and state income taxes, as well as Social Security taxes, Medicare taxes, state unemployment insurance, and state disability insurance. For independent contractors, this withholding is not required, and an employer will instead use Form 1099-NEC to report payments that are made. The worker will pay income taxes to the IRS and state tax authorities such as the California Employment Development Department (EDD), and they will also pay self-employment taxes.

An employer cannot misclassify workers as independent contractors in order to make the tax filing process simpler or to avoid providing certain benefits. Misclassification may result in an employer being held liable for paying the employment taxes that were due for a worker. To determine whether a worker should be considered an employee or independent contractor, the IRS may consider several different types of factors, including:

• Behavioral control - These factors address the level of control an employer has over when, where, and how a person performs work. If an employer requires a person to do work at a certain time and in a certain location while specifying the tools and equipment they can use, the person is more likely to be considered an employee. However, workers who have a greater degree of independence and only receive direction regarding the results of the work they are expected to perform are more likely to be considered independent contractors.

• Financial control - These factors look at how an employer addresses the expenses related to a person’s work. If an employer pays for the equipment a person uses, reimburses work-related expenses, and pays wages on an hourly or weekly basis, this may indicate that the person is an employee. However if a person is expected to provide their own equipment, pays their own expenses, and are paid a flat fee for work performed, they are more likely to be considered an independent contractor. 

• Nature of the employment relationship - The permanency of a person’s employment may be a factor used to determine a worker’s classification, including whether they receive benefits such as health insurance from an employer. The nature of the work a person performs may also be considered; if a person’s work is an essential part of a company’s operations, they are more likely to be considered an employee. 

Contact Our San Jose, CA Employment Tax Attorney

If you have questions about how your classification of workers will affect your tax obligations, John D. Teter Law Offices can advise you on how federal and state tax laws affect you. We can also help you determine how to respond to state (Employment Development Department) or federal (Internal Revenue Service) audit notices and/or claims that you have misclassified workers, and we will work with you to resolve these issues and minimize potential penalties. Contact our San Jose employment tax lawyer at 408-866-1810 to set up a consultation and discuss these and other tax-related issues.

Sources:

https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee

https://www.irs.gov/businesses/small-businesses-self-employed/forms-and-associated-taxes-for-independent-contractors

https://www.irs.gov/pub/irs-pdf/p1779.pdf