Misclassification of employees as independent contractors

src: r1.cpapracticeadvisor.com

Misclassification of employees as independent contractors in the United States can occur with respect to tax treatment or the Fair Labor Standards Act. According to US labor standards, workers are properly classified as employees when

The U.S. Government Accountability Office (GAO) reports that the IRS claims to lose millions of dollars in uncollected payroll, social security, Medicare and unemployment insurance taxes because of misclassification of independent contractors by taxpayers.

According to Internal Revenue Service (IRS) Commissioner Mark W. Everson in a statement made November 3, 2005, IRS audits of small businesses organized as corporations increased from 7,294 in 2004 to 17,867 in 2005. [1]

Video Misclassification of employees as independent contractors

Taxation

Employers must report the incomes of employees and independent contractors using the IRS forms W-2 and 1099, respectively. Employers pay various taxes (i.e. Social Security and Medicare taxes, unemployment taxes, etc.) on the wages of a worker that is classified as an employee. These taxes are generally not paid by the employer on the compensation of a worker classified as an independent contractor. Instead, the contractor is responsible for their employer's share of the taxes when he or she pays self-employment taxes at the end of the year.

Classification affects whether a worker can receive unemployment benefits. In many states, independent contractors are not eligible for unemployment benefits because nothing has been paid into the unemployment insurance fund on their behalf. Employers who have no employees are not required to make payments to the unemployment insurance fund (since there is no one to claim benefits).

Workers classified as independent contractors whose contract is terminated can contact their state unemployment agency (for example Employment Development Department (EDD) in California) and file a claim for unemployment. EDD investigates and determines whether the worker was misclassified, and potentially award unemployment benefits. According to state-level studies, 10% to 20% of employers misclassify at least one worker as an independent contractor.

Maps Misclassification of employees as independent contractors

Reclassification

IRS reclassification as an employee occurs where persons claimed as (or claiming to be) independent contractors are recategorized by the Internal Revenue Service (IRS), or by state tax authorities, as W-2 employees. The reclassification can result in the imposition of substantial fines, penalties and back-taxes for which the employer is generally liable.

src: brandoracollective.com

Employee vs. independent contractor

IRS regulations state that a worker is an employee if the employer can control what is to be done and how it is to be done. This was codified in revenue ruling 87-41, and is generally called "the twenty factor test". By contrast, if the worker controls the means and method of achieving the required results, leaving the employer with the right only to define the desired result, they are correctly classified as an independent contractor.

Employees and independent contractors have very different benefits. Employees are entitled to the protection of wage and hour laws and are protected from discrimination and retaliation by employers. Employees may be legally entitled to family medical leave and benefits such as medical insurance and pension plans. Employees are entitled to bargain collectively with their employers. Employees are entitled to workers' compensation for job-related injuries and employers must pay into social security, Medicare, and unemployment insurance for their employees. No benefits or employer tax payments are available to contractors, who must pay for their own benefits and unemployment taxes.

Service sector employees are more likely than others to be misclassified as independent contractors. Commonly misclassified positions include delivery and taxi drivers, nurses and home health aides, housekeepers and adult entertainment workers.

Efforts by firms in the sharing economy such as Uber to maintain independent contractor status for "partners" such as Uber drivers have been questioned.

IRS Form SS-8 can be filed with the IRS to request that the agency determine the classification of a worker.

src: image.slideserve.com

Fair Labor Standards Act

In July 2015, the U.S. Department of Labor issued new guidelines on worker classification. "A worker who is economically dependent on an employer is suffered or permitted to work by the employer. Thus, applying the economic realities test in view of the expansive definition of "employ" under the Act, most workers are employees under the Fair Labor Standards Act."

src: image.slideserve.com

See also

• Similar questions in UK: IR35

src: image.slideserve.com

References

src: hbr.org

External links and resources

• "IRS Offers Tips on How to Correct Reporting of Misclassified Employees", irs.gov, March 27, 2006
• "Avoiding IRS reclassification of workers as employees.", Tracy A. Freeman, The Tax Adviser, February 1 1996
• "FedEx Drivers Fight for 'Employee' Status, Rights", Megan Tady, The NewStandard, July 18, 2006
• "Sebelius Announces Campaign to Ensure Fairness for Kansas Workers and Businesses", infozine.com, July 11, 2006
• "Waxman: Blackwater may have evaded millions in taxes", Justine Redman, CNN, October 23, 2007
• "In the Sharing Economy, Workers Find Both Freedom and Uncertainty", Natasha Singer, New York Magazine, August 16, 2014
• "I was 1099'd: Employer Liability for Independent Contractors in the Service Sector", Melinda Pilling, Rukin, Hyland, Doria & Tindall, October 8

Source of the article : Wikipedia