Independent Contractors vs. Employees.

IRS and State Tax / Department of Labor audits try to force business to mis-classify workers as employees.

Does your firm use outside workers for some jobs? This can result in significant savings if they properly classify the workers as independent contractors rather than employees. Also, the worker can have many deductions as a Schedule C business filer rather than an employee. Typical fields for independent contractors are:

! construction
! framing
! painting
! roofing
! nurses
! sports officials
! bookkeeping
! contract clerical and back-office
! data entry
! computer programming and IT
! financial analysts
! drivers and delivery
! music instructors
! driving instructors

Tax Treatment of Employees vs. Independent Contractors

If a worker is an employee, your company must withhold from his or her wages:
federal income tax
Social Security and Medicare (FICA)
state and local taxes
employment taxes (such as unemployment and disability)

In addition, your business is responsible for paying the employer’s share of federal payroll taxes. The employee cannot deduct travel expense from home to work, and there is a 2% floor before unreimbursed business expenses (home office, internet, phone, travel, dues, subscriptions) can be deducted on the US 1040.

If a worker is characterized as an independent contractor, your company is not liable for payroll tax obligations. Further, the worker can file a Schedule C in the 1040 and deduct all of the expenses for:
! home office
! internet
! phone
! insurance
! travel
! postage and delivery
! dues
! subscriptions

Independent contractors do not receive fringe benefits that regular employees receive. Also, they generally provide their own equipment and supplies.

Who is an Independent Contractor?

Distinguishing independent contractors from employees is not always easy. There are several factors the IRS and courts examine but “control” is the first issue. If your business controls how, where and when the worker does the job, they usually classify him or her as an employee.

There are a variety of other tests, such as where the worker performs services, if they do services for others, and how the file their taxes. The IRS and State Tax agencies and Department of Labor continues attacking companies that hire independent contractors. If the tax agency “reclassifies” a worker as an employee, a company could be subject to large bills for back taxes, interest and penalties. Audits by state agencies are also common and frequently occur when independent contractors apply for unemployment or Workers’ Compensation.

The best way to handle this is to immediately have the appropriate contracts and agreements and the proper set-up for the independent contractor. This requires tax and legal advice.

If you have a question call Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856) 665-2121.