Q: I am a small business owner. How do I know whether to classify my workers as employees or independent contractors?
A: Employers are required to withhold and pay Social Security and Medicare taxes for employees, as well as pay federal unemployment taxes on behalf of employees. However, employers who hire independent contractors do not pay these taxes. The main common law factor for determining whether a worker is an employee or independent contractor is the amount of control the employer has over a worker. When the employer controls the daily work, the worker is more likely an employee. Construction workers are frequently misclassified as independent contractors to save the employer from paying over 7% of the worker’s wages to Social Security and Medicare. If the IRS retroactively reclassifies independent contractors as employees, the employer will be assessed with employment taxes, penalties, and interest.
The IRS provides a safe harbor from retroactively reclassifying independent contractors as employees if the employer meets the following three requirements.
For taxpayers that have misclassified their workers as independent contractors, the IRS provides amnesty through the Voluntary Classification Settlement Program (VSCP). Employers are eligible for VSCP if the following three requirements are met. The employer consistently treated the workers as independent contractors. The employer filed all Forms 1099 for the last three years. The employer is not currently under audit by the IRS, Department of Labor, or state agency concerning the classification of the workers. Under the VSCP, the taxpayer only pays 10% of the employment tax liability that would have been due for the most recent year had the workers been properly classified as employees. Interest and penalties are waived. The IRS is not permitted to audit worker classification for prior years.