payroll tax Archives | Wheeler Accountants, LLP

The consequences of misclassifying an employee as an independent contractor can be costly. You could be liable for back taxes (including the employee’s shares of unpaid payroll and income taxes), penalties and interest. There may be serious nontax consequences as well.

How Important Is This?

Businesses must withhold federal and state income taxes and the employee’s share of Social Security and Medicare taxes from employee wages. They must also pay the employer’s portion of Social Security, Medicare and unemployment taxes for employees. Generally, none of these obligations apply to the business for workers who are independent contractors.

Misclassifying an employee as an independent contractor can result in liability for unpaid payroll taxes, penalties and interest. You may also owe the employee’s share of taxes.

Beyond taxes, misclassification can mean liability for minimum wages, overtime pay, benefits, workers’ compensation, and state disability insurance. Ensuring proper classification helps avoid costly legal and financial consequences.

What Factors Should You Consider?

Determining the correct classification requires reviewing the key factors that the IRS evaluates. No single factor is conclusive; all must be taken into account.

Here are the three categories of factors the IRS assesses:

1. Behavior control

Who controls what work is done and how it’s performed? A higher degree of control suggests the worker is likely an employee. It’s important to consider how much training and education the business provides a worker to do the job.

2. Financial control

Who controls the economic aspects, such as how the worker is paid and how expenses are reimbursed? Independent contractors generally have financial risk. They may work for flat fees and work for more than one business.

3. Type of relationship

Workers hired for an indefinite period and performing core business functions are more likely to be employees.

Labeling a worker as an independent contractor in a written contract doesn’t make it so. However, it may serve as evidence in a dispute between parties.

How Does Remote Work Affect Classification?

It’s tempting to think that if a person works for you remotely, he or she automatically qualifies as an independent contractor. Not so fast! Even if the individual chooses to work remotely, the classification is still subject to scrutiny.

The key considerations are the same as for on-site workers, such as whether you, as the business owner, have the right to control the details of the worker’s services and how they’re performed.

Worried You’ll Make a Mistake?

Don’t underestimate the importance of this issue. The consequences of misclassification can indeed be severe. Using a reasonable basis for classifying workers may relieve penalties and employment taxes.

You can ask the IRS to weigh in by filing Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” Before you do this, contact the office and ask for a review of the details.

Beyond Federal Taxes

Even if you’re confident in your classification of workers for federal tax purposes, it’s essential to consider how they’re treated under state taxation and federal and state wage and hour regulations. Classifying workers as employees in some cases and independent contractors in others can create significant administrative challenges, so evaluate their status comprehensively before making a final decision. Don’t risk a mistake. Answers to your questions are a phone call away.

408-252-1800

Photo by Ivan Radic via Flickr.com.

If you own or manage a business with employees, you could be personally responsible for paying a harsh tax penalty. It’s called the Trust Fund Recovery Penalty (TFRP). It applies to the mishandling of Social Security and income taxes that must be withheld from employees’ wages.

These taxes are government property employers collect and hold in “trust” for the government until payment. If the funds aren’t properly handled, the IRS can impose a TFRP equal to 100% of the unpaid taxes on each responsible party. Consequently, the penalty amounts can be significant.

A Penalty with a Long Reach

The TFRP is among the more dangerous tax penalties not only because it’s large but also because it applies to many actions and people involved in a business, and historically, the IRS has aggressively enforced it. Here are some questions and answers to help avoid incurring the penalty:

What actions are penalized?

The TFRP applies to willful failures to collect or truthfully account for and pay over Social Security and income taxes required to be withheld from employees’ wages.

Who’s at risk?

The IRS can impose the 100% penalty on anyone “responsible” for collecting and paying taxes. This includes corporate officers, directors, shareholders, partners and employees with such duties. Even voluntary board members of tax-exempt organizations may be liable under certain circumstances. Sometimes, responsibility has been extended to family members close to the business, attorneys and accountants.

How is responsibility determined?

Responsibility depends on status, duty and authority. Anyone with the power to ensure taxes are paid can be held liable. Multiple people within a business can be deemed responsible, and each is at risk of a full penalty. If you know unpaid payroll taxes exist and have the authority to pay them but prioritize other payments instead, you could be deemed a responsible person.

While a taxpayer held liable may sue others for contribution, this must occur after paying the penalty in full. Such lawsuits are entirely separate from the IRS’s collection process.

Definition of “Willful”

Willful actions don’t require intent to evade taxes. The IRS defines “willfully” as knowingly prioritizing other expenses over withheld taxes. For example, bending to pressure to pay other bills instead of taxes is considered willful behavior.

Delegating actual tax responsibilities is no defense. Failing to deal with tax tasks can also be deemed willful.

“Borrowing” is Never an Option

Under pressure, it may be tempting to “borrow” from a tax withholding fund to pay an urgent expense. But don’t do it. The importance of paying all funds withheld from employee paychecks over to the government can’t be understated. Failure to pay can result in multiple people owing the hefty 100% TFRP, including people who didn’t realize they were considered responsible. Contact the office with any questions.

408-252-1800

Photo by Andrew_Pons from Freerange Stock.

Business Owner payroll payroll tax trust fund recovery penalty

The High Cost of Worker Misclassification: Tax Implications and Risks