Article by David Heier
For years, the United States Treasury has relied upon employers to be their unpaid tax collectors. Most people do not realize that when someone is an employee of a business, the business owner is responsible for collecting the federal, social security, Medicare, state and local income taxes from the employee. The employer then has to pay these trust fund withholdings into the United States Treasury, along with the various states and cities. To add insult to injury, the employer has to match the 7.65 social security and Medicare tax and include it in their weekly, monthly or quarterly deposits. The business owner also has to pay federal and state unemployment taxes which can be substantial. The business owner is also required to carry workers compensation insurance on their employees. This rate can vary, however, in some industries, the workers compensation rate can be as high as 30% of gross wages.
It is logical to conclude that most business owners would not want to have people classified as employees. After all, if the worker is an independent contractor, the business owner does not have to be concerned with being an unpaid tax collector who has to carry workers compensation insurance and pay abusive unemployment and social security/Medicare taxes. So business people got smart, or so they thought. They classified all of their workers as independent contractors. What happens next?
Workers who are classified as independent contractors get paid a gross check without any withholding for taxes. As is human nature, we often spend what, or more than we earn. They do not save any of their check for taxes. Or maybe the business owner never told them that they would be classifying them as independent contractors and giving them a form 1099 at the end of the year. Independent contractors fail to realize how much tax is really due for their earnings. Or perhaps the business owner said I am giving you a check but nobody will ever find out. Then the 1099 form arrives in the mail. The worker goes to her or his accountant and discovers how much they owe. They do not have the money to pay their taxes and the governments do not get paid. Accordingly, this has, and continues to be one of the main reasons that the government wants independent contractors classified as employees. Fast forward to the Affordable Care Act (Obamacare). The government has a new incentive to have workers classified as employees.
There is no specific test to determine if a worker is an independent contractor or employee. There are several factors that are examined. After evaluating all of the facts and circumstances, there should be one way or another that points to the determination of independent contractor or employee. Some specific factors that are reviewed include, but are not limited to:
- Are you paid by the hour or by the job
- Whose tools and equipment do you use
- Do you work exclusively for the business owner
- Do you carry your own liability and workers compensation insurance
- What is customary in YOUR industry
- Do you work specific hours
- Do you take direction and orders from the business owner
- Do you advertise
- Do you have contracts for each job
- How are the fees set
These are just an example of what the government looks at when making the argument that your independent contractors are actually employees.
If you are audited by the IRS, state or city and they determine are successful in reclassifying your independent contractors as employees this can be catastrophic. You could be required to pay what you should have withheld to the employees for all periods under examination. Imagine having 60 people who you paid $ 30,000 per year for 3 years and incorrectly treated them as independent contractors. The social security tax alone would be over $ 275,000. Add to that the federal income tax, state income tax, unemployment tax, city income tax and now Obamacare penalties. It could be enough to put you out of business.