As you know, employers generally “must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. [They] don’t generally have to withhold or pay any taxes on payments to independent contractors.” Many companies try to circumvent this requirement by classifying most or all of the staff members as independent contractors.
This can be financial and regulatory suicide for a business if it is done incorrectly. The IRS has very specific guidelines for the criteria applied to professional relationships in order to determine whether the individual is an employee or an independent contractor (1099).
The three overall tests are:
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job.
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Through its new Voluntary Classification Settlement Program (VCSP), the IRS is offering business an opportunity to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS.