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Employee or independent contractor? You need to know

As an employer, one of your more important jobs is to properly determine if the individuals who work for you are employees or independent contractors. You probably know that employees bring with them a host of obligations for you as an employer. Payroll taxes and withholdings are one of the most important of those obligations, as the Internal Revenue Service imposes severe penalties for employers who are negligent with these withholdings.

The reason is simple. The payroll tax withholdings that you manage for your employees are not your money. The IRS treats all of that cash flow as a trust, and because of that, you are held to the fiduciary standards of a trustee. This is why the penalties can be very severe if you failed to withhold correctly or if you have misclassified employees in an effort to avoid that obligation.

The basic test for determining employment status involves the behavioral control, financial control and the relationship you have with your workers. The behavioral control is demonstrated if you have the ability to control not just the work, but how the worker handles the work. If you can direct how they complete a job, they are likely employees.

Financial control would be shown by your control of how they spend money or purchase tools and equipment. The relationship element is demonstrated by how the workers and business perceive their interaction.

Some businesses will attempt to lower their costs and administrative duties by classifying workers as independent contractors, but then treat them in all other aspects as employees. This can result in a business owing substantial back taxes and penalties. If you cannot reasonably determine their status on your own, you can submit a Form SS-8, entitled "Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding."

Employees can also submit this form, which is likely when they believe they have been misclassified. If you are unsure of the proper classification, you should discuss the matter with your tax attorney and submit a Form SS-8 before problems develop and penalties accrue.

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