There is a significant confusion surrounding the determination of a worker's classification as either an employee or an independent contractor for federal income and employment tax purposes. This issue can become intricate and fraught with risk. How then, can we distinguish between them?
To be classified as an employee, it is necessary to fulfill the criteria of being a full-time, 40-hour-a-week worker consistently performing the same job and maintaining employment with a single employer. However sometimes part-time people can be employees as well. Employers are obligated to remit the employer's portion of employment taxes while also deducting the worker's share. Additionally, employers possess the authority to supervise and direct the employee's work process.
However, if you operate as an independent contractor, you benefit from the flexibility inherent in this status. The employer's influence is limited to defining the desired outcome or final product, without dictating the specifics of your work process. However, it is important to note that independent contractors do not receive the same benefits, salaries, and employment tax considerations as employees.
If you are employed by a company, the company is responsible for paying payroll taxes on your behalf, including ½ of the FICA taxes on wages and FUTA tax. Additionally, the company often provides fringe benefits that are available to other employees. There may also be state tax obligations to consider.
However, independent contractors are regarded as self-employed individuals and bear the responsibility for their own taxes, benefits, and insurance. The business issues them a Form 1099-NEC (Non-employee Compensation) at the end of the year, which displays the total amount paid to the contractor (if it exceeds $600). This concludes the obligations between the parties involved.
When identifying someone as an independent contractor, several considerations may come into play, including:
Tax Planning Being an Independent Contractor:
As a W-2 employee, you may have fewer options for tax planning compared to being a 1099 contractor. By transitioning to a 1099 job, you can leverage various tax planning strategies, such as:
There are three sets of tests to determine whether a worker is an employee or an independent contractor. These tests are:
The "Right to Control" Test under Common Law: This test is predicated on a customary legal benchmark and places emphasis on the level of control wielded by an employer over the worker. Numerous factors are considered, such as the extent to which the employer possesses authority over the specifics of the work, whether the worker is involved in a separate occupation or business, and whether the work is typically performed under the employer's guidance.
Incorrectly identifying employees and independent contractors can have significant legal and financial consequences for both employers and workers. Employers who carelessly categorize workers as independent contractors expose themselves to substantial liability under Federal Law if these workers are misclassified. The Internal Revenue Service (IRS) may pursue the recovery of back taxes and other contributions that should have been paid by the employer on behalf of the employees. Also, workers have the right to seek compensation for job benefits denied to them based on their mischaracterized status as independent contractors.
It is important to note that the specific factors used in each case may vary depending on the work relationship's context. In certain instances, courts may also consider other factors, such as the intent of the parties involved or the level of permanence in the work relationship, when deciding regarding worker classification.
If you are confused about your employment status, it is advisable to seek professional advice. Investor Friendly CPA® is readily available to assist you with your concerns. We have a team of expert professionals who can help you determine your employment status.