 Internal Revenue Service IRS Tax News. Worker Classification 101. Employee or Independent Contractor. Worker Classification 101. Oh no, is this where they're gonna try to teach us about our pronouns? I had a horrible time understanding pronouns in grade school English, and now it's like they changed all the rules. Can't I just skip the training and like pay more taxes or something? What's that Phil? No, because then I'll be causing physical harm to people around me by throwing he's and hers at people. But wait a second. He's and hers aren't physical things, Phil. They're not physical, and I don't throw he's and hers. I say he's and hers at people, or two people, or whatever. First, an attempt at a joke. President Biden is confused about how inflation happened. I'm confused. He's like, hey, there's something fishy going on around here. I'm telling you. Fishy, fishy, fishy, fishy, fishy, fishy, fishy. There's fishy things afoot. Fishy, fishy, fishy, fishy, fishy. Which is super strange, because fish don't have feet. Patrick, you don't have feet. Oh! So how's it we got so much fishy stuff afoot? Like inflation, war, economic downturn. Uh, sir, one brave reporter responds, your feet are in the tide pool. That's your foot. Stepping on the fish. Nothing gets by you, does it? In other words, there's fishy things afoot. Strange things are afoot at the circle king. Because the fish are just doing what fish do, and you're the foot. You are the problem. Stepping on him. And Biden's like, wow, you totally blew my mind, dude. Wow, that blew my mind. Brilliant deduction, Watson. Reporter responding, you're welcome, sir. Now, would you please get your dang feet out of the tide pool of the economy? Get your foot out of it. It's clearly causing a lot of suffering. IRS tax tip 2022-117 August 2nd, 2022. A business might pay an independent contractor or an employee for the same or similar work, but there are key legal differences between the two. So when we're talking about an employer, for example, and then another person that's going to be doing work, the classification could be then an independent contractor or possibly an employee. Now, you might think, hey, look, that's gonna be a decision that should be made between those two individuals, A and B, the two individuals involved. But then we have C over here, which is the IRS, which you might say, why don't you just go see your way out of here, IRS? But no, that's not gonna happen. So they have their interest as well. So we wanna know what are the pros and cons of being an employee or independent contractor to both the employer, to the employee or independent contractor? And then what are the IRS's incentives involved in this? And then we wanna know when someone should properly be classified as an employee or independent contractor because the IRS tries to make it something that should have like a hard line, right? So we should kind of know whether someone is an employee or a contractor because again, C has their interests and they are imposing those interests on our definitions on our classifications here. So keeping that in mind, it is critical for business owners to correctly determine whether the people providing services are employees or independent contractors. So it does make a big difference in terms of what your responsibilities will be as the employer or the person hiring an independent contractor. So here's some information to help business owners avoid problems that can result from misclassifying workers. And employee is generally considered anyone who performs services if the business can control what will be done and how it will be done. So let's give a quick recap on the incentives here. Note that on the employer side of things, the easy, if there was no taxes involved, paying an employee would be the same as basically any other kind of thing that we would have an expense for. We would just pay for it and we would record it as employee expense done. But as we know, of course, there's a lot of things other than that involved with an employee, a main factor being that the employer is required to withhold taxes. We got to get the W-4, we got to do the withholdings. So the IRS is basically requiring the employer to be their tax collector. So the employer is now mandated to actually do the withholdings, pay that money to the IRS, and then track the information so they can report what has been done to both the employee and the IRS in the form of a W-2 and W-3 and so on at the end of the year. That's a lot of work to do on the employer side of thing that's kind of added on to what would normally be just a simple expense type of transaction. On the other hand, if they were a contractor that could be easier on the employer in some ways because then it is similar to a situation where you just have another expense, although you might have to give them like a 1099, but that's gonna be a lot more of a simple process. So you can see on the employer side of things, they might have some incentives to classify someone as an independent contractor at least from the ease of how easy it would be to do something. Now, employers have other incentives to have employees because if you have someone as an employee, then you can kind of lock them in by giving them incentives and so on that they would lose if they were to leave the employee-employer situation. So then that could be an incentive and so on. But that's that side. Now, on the employee side of things or the independent contractor side of things, it could go either way. You might think, well, maybe, and the IRS will often argue that it's a benefit to the employee to be classified as an employee other than an independent contractor, but that's really kind of biased to the IRS because the IRS, that's what the IRS prefers because the IRS wants to be able to track everything more in more detail and get more information using the employer to do so. But the employee does have a benefit from being an employee because then sometimes they get benefits for as an employee, for example, and although they pay the taxes for federal income tax, social security, and Medicare, they really only pay half the social security and Medicare on the payroll tax side of things and then the employer has to pay social security and Medicare as well. So that, because if they were an independent contractor, they would be paying self-employment tax, which includes the social security and Medicare basically for the employer and employee. So in essence, you pay more on the net income if your net income was equal to your wages and social security and Medicare through self-employment tax as an independent contractor than if you got the same amount of money through W-2 wages. However, as a contractor, you can deduct a lot more stuff because if you're using your own tools and stuff, you got a lot more deductions and that could be a huge benefit lowering the amount of the taxable income and so on. So it could be a benefit either way to be a contractor or an employee, it just depends on what your desire is on the contractor or employee side of things. Keep in that said, the IRS clearly has an incentive to try to get people to be an employee because they want the leverage over the employer to force the employer to give them all your wage information so they can track your earnings and make sure they get paid from you for your earnings, which they can't do so much if you were a contractor. They can only get a 10.99. They can't force them to give you the withholdings. Okay, keeping those incentives in mind, they're gonna try to force us to do the classification and act like it's a really solid line between what's a contractor and what's an employee. So how do you determine between the two so you don't get in trouble from the IRS? Well, if you're controlling all the information that the employee does, meaning it's a nine to five job, for example, and they're at the desk and doing whatever you tell them to do at that point, well, it's pretty clear at that point since you have the control, not only how they're gonna do the job, but what job and how to do the job, then they're gonna be an employee. So what matters is that the business has the right to control the details of how the worker's services are performed, so you can contrast that to an independent contractor. So if you said, even if they work for you like all the time, but you're saying you just point them to the job, you're like, I want you to go over there and paint the place or whatever, paint the fence or put in the stucco into the house or do what it do. If you do online, put the website together or something like that. As long as you, and they can do whatever they do it so they can bring in their team. I'm not telling you who to hire. I'm not telling you how to do it. I'm not giving you, I'm giving you a deadline. I'm not telling you when exactly you need to work on it and so on and that kind of stuff. You're using your own tools. That would be more of an independent contractor type of situation you would think. So if I, but if I'm looking over your shoulder and every detail that you're doing you would think that'd be more of an employee situation. So it's not a hard line. It's a fuzzy line. So independent contractors are normally people in an independent trade business or profession in which they offer their services to the public. Independent contractors versus employees whether a worker is an independent contractor or an employee depends on a relationship between the worker and the business. Generally there are three categories to consider. So they're gonna look at these three categories and the IRS is gonna try to determine where they lie. So if they come after you on this, they could say, look you hired someone and categorized it as a contractor. We think they should be an employee. These are the kind of things they're gonna look at. So you wanna make sure that you have them in your mind. You have the arguments in place and saying, this is why I classified however I classified. So you got the behavioral control. So does the company control or have the right to control what the worker does and how the worker does the job? So they looking over the worker's shoulder to see what they're doing and how they're doing it or is it just like just do the end product and tell me what it's done. So financial control. Does the business director control the financial and business aspects of the worker's job or the business aspects of the worker's job controlled by the payer? So the kind of financial aspects to keep their business. Are you paying for the tools and that kind of stuff or are they paying for what they need to do to run a business in and of themselves? Things like how the worker is paid, our expenses reimbursed, who provides tools, et cetera, et cetera, relationship of the parties. Are there written contracts or employee type benefits such as pension plan, insurance, vacation paid? Now notice these are kind of things that are usually good for the employer because they kinda lock in the employee. So if you have a good employee, you'd like to say, ah, you got your pension plan, you got your insurance and your vacation pay because if they leave before those fulfillments, those contracts are fulfilled, then they lose those things, right? So that's a way that it could be beneficial for an employer to kinda lock employees in to some degree. So while the relationships continue, is the work performing a key aspect of the business? Notice if you don't have these things like pensions, insurance and you just pay them a salary as an employer, then the employee is good to go anywhere else anytime they want, which is fine. But obviously sometimes an employer is looking for stability and how they can lock in stability is offered, these types of things, and so on. In any case, misclassified workers. Misclassified workers, so what happens if I don't, is the common response here. What if I classify the way we determine between A and B and you could see your way out IRS? Well, here's what happens. Misclassified workers as independent contractors adversely affects employees because the employer's share of taxes is not paid and the employee's share is not withheld. So note that the argument on the IRS will typically be, well, if you classify someone as a contractor instead of an employee, you're doing them a disservice, which isn't always true. Maybe they would like to be an employee, but that's not always the case because they might have more deductions and so on on their side. So in other words, that's because the employer is not paying their share of the employer taxes. Instead it's being calculated in the payroll taxes and self-employment tax on the employee side of things, which again, could go either way in terms of whether it be good or bad for the contractor or employee. If a business misclassified an employee, the business can be held liable for employment taxes for that worker. So the IRS, notice where the IRS sits, they want to classify as an employee. That's where they have the leverage. That's where they can tell the employer, you are now our tax collector and you better be collecting our taxes and paying them and giving us the W-2. And if we determine that someone is an employee, you categorize them as a contractor. You might have to then go back and pay the self-employment tax that you didn't pay, which is the Social Security and Medicare, and that could be painful. So generally an employer must withhold and pay income taxes, Social Security and Medicare taxes, as well as unemployment taxes. So that's the other one, it's not as big. That's the worker or employer tax, that being the unemployment. So workers who believe they have been improperly classified as independent contractors, generally must receive a determination of worker status from the IRS. There's a link to that here. So if you want to be an employee and you think you're being misclassified, then there's that situation. So then they can use form 8919, uncollected Social Security and Medicare tax on wages. Obviously, if you were to take that route, it might not sit well with the employer or the person you're working with, but in any case, you might want to find someone where you agree on what your status is. But in any case, to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation. So voluntary classification settlement program, the voluntary classification settlement program, there's a link to that here, is an optional program that provides businesses with an opportunity to reclassify their workers as employees for future employment tax purposes. This program offers partial relief from federal employment taxes for eligible businesses who agree to prospectively treat their workers as employees. So in other words, you might be in a situation where you're saying, well, no status has changed for my employee or my contractor that I've had as a contractor. But I think maybe the IRS is gonna claim them as an employee, but if I start claiming them as an employee now, maybe the IRS will come back and say I owe self-employment taxes for the whole time that they were employed. So in that case, obviously the IRS wants to incentivize you to make the change. And that's why they might get, so that's the idea here. We're gonna say, well, okay, maybe we won't go back and try to completely cripple you by trying to collect the self-employment tax for the last five years that they were a contractor if you start pushing forward at this point in time. So if that's a concern, you can go into some more reading materials here. Businesses must meet certain eligibility requirements that apply for filing Form 8952 application for voluntary classification settlement program, VCSP and enter into a closing agreement with the IRS. Who is self-employed? Generally someone is self-employed if any of the following apply to them. They carry on a trade or business as a sole proprietor or independent contractor. So if you're just doing your own business, you're self-employed. They are a member of a partnership that carries on a trade or business. They are otherwise a business for themselves including a part-time business. So you can be part-time and still be a business even if it's like a part-time, sole proprietor type business. Self-employed individuals, including those who earn money from gig economy work. Uh-oh, here they go. IRS is going after the gig economy. That's right, you gig people. You're self-employed. You owe taxes, say the IRS. Make sure to pay those even if you don't get a 1099. There's a link to the gig economy are generally required to file a tax return and make estimated quarterly tax payments. So don't forget that gig people says to IRS. So they also generally must pay self-employment tax which is social security and Medicare tax as well as income tax. These taxpayers may qualify for the home office deduction. So you got that going for you. A little bit of, they're trying to throw you a little something for your trouble. If they use part of the home business, so you got a link to that here. There's links to all that stuff here. There'll be a link to this in the description.