The independent contractor filing blues
The acceleration of the due date for filing independent contractor forms with the Internal Revenue Service has put pressure on small businesses and their tax preparers.
Independent contractor forms, along with W-2s, are now due to the IRS by Jan. 31, 2019. The date was moved up by the PATH Act, which also moved the filing deadline for W-2s to the earlier date. The earlier date helps the IRS more efficiently verify income that individuals report on their tax returns and helps prevent fraud.
“States tend to follow the federal government,” said Todd Waletzki, president of the payroll division of BenefitMall, a large payroll company and the largest general agency helping brokers provide insurance benefits for small businesses.
“We are seeing filing deadlines being compressed, and it compels us to keep our clients informed of accelerating deadlines and help them close out year-end taxes in a timely manner,” he said. “We file employment tax returns, such as Form 921, and provide packages to our clients and their CPAs to help them file their business returns.”
“There used to be separate due dates, one for the payee form on January 31, and one for the IRS version due on February 28,” said Vincent O’Brien, of Vincent J. O’Brien CPA PC.
The earlier due date only applies if Box 7 on Form 1099-MISC is checked, according to O’Brien.
“If you have a 1099-MISC with other information, then it won’t be due on the earlier date,” he said. “That time frame compresses tax season a lot. But if you’re reporting anything other than Box 7, non-employee compensation, then the end-of-February due date still applies.”
“And it goes beyond that. If you pay someone other than a corporation, you are required to send them a Form 1099 for payment for their services if it amounts to more than $600,” he continued. “That would include someone like a plumber or electrician that comes to the office. If they’re organized as a corporation such as ‘Acme Plumbing Inc.,’ it wouldn’t be necessary to complete Form 1099-MISC for them, but if they’re organized as a sole proprietor you have to send the form. There are severe penalties if you don’t.”
The same holds true for clients of an accounting firm, O’Brien noted. “If the accounting firm is organized as a partnership or an LLC but is not incorporated, the accounting firm’s clients are supposed to send the firm a 1099 if their payments to the firm amounted to more than $600 in the aggregate during the year.”
The thorniest of issues
The classification of a worker as an independent contractor rather than a worker can be exceedingly complex, and depends on the facts and circumstances of each case. The determination is based on whether the person for whom the services are performed has the right to control how the worker performs the services.
“An employee is technically controlled by the employer, managing what they do, how they do it, and when they do it,” said BenefitMall’s Waletzki. “However, an independent contractor may be told what project is needed and when it’s due, but they are in control of the way they go about it.”
Both of these statuses have pros and cons, according to Waletzki. “Some advantages of hiring employees include the fact that the hourly wage is usually less, the employee is routinely available to work 30-plus hours a week, and can require less training. Disadvantages of hiring employees include the cost of providing benefits, consistently scheduled payment, and increased payroll paperwork.”
“With an independent contractor, overall cost can be less and employers are provided more flexibility when it comes to replacement and assignment,” Waletzki said. “Additionally, the independent contractor handles licensing and permits. However, some of the disadvantages include less control over the individual. Since the independent contractor’s time is their own, they can say no to a project, and have no sense of loyalty.”
Employers who mislabel their workers as employees escape the obligation of paying minimum wages, overtime, payroll taxes, worker’s compensation, unemployment, Social Security, health benefits, paid leave, and retirement benefits. Workers themselves benefit by being classified as independent contractors by being able to deduct certain business expenses that are not available to employees, the ability to set up their own retirement plans, and the fact that they are not subject to withholding.
But there are serious consequences to misclassification of a worker as an independent contractor. If the worker is determined by the IRS to be an employee, the business is liable for the taxes it neglected to withhold, in addition to the employee’s share, plus interest and penalties.
The filing of Form 1099-MISC helps employers protect the status of a worker as an independent contractor, according to Waletzki.
“Employers provide one copy to the contractor and another to the IRS. The independent contractors use the forms to keep track of their own income for tax purposes,” he said. “Since they self-pay FICA taxes, employers do not deduct any payroll taxes from contractor pay.”
The IRS has kept a close eye on this issue in the past several years, Waletzki noted.
“Employees tend to be more expensive than independent contractors, since the employer must withhold federal income tax and FICA taxes on the wages of the employee, pay state taxes and any benefit premiums,” he said. “None of these taxes apply to independent contractors, so employers have a financial enticement to prefer them. But they should know that misclassifying workers is bound to bring hefty penalties and fines.”
And it’s easy for a business or accountant to make a mistake because there is no bright-line test. The IRS has used both a 20-factor test based on common law principles, which it has condensed into a three-part test focusing on behavioral control, financial control, and the relationship of the parties. States may follow the federal tests or have their own more restrictive rules.
Recently, the California Supreme Court adopted a new three-part test to make the determination under California’s wage orders, which regulate wages, hours and working conditions, Waletzki said.
This new “ABC” test requires a company to establish three factors to classify a worker as an independent contractor:
A. The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
B. The worker performs work that is outside the usual course of the hiring entity’s business; and,
C. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.
“Prior to the ABC test, the Borello analysis was the primary consideration in determining if an employment relationship existed,” Waletzki said. “This analysis focused on whether the company has the right to control the manner and means in which the worker performs tasks and completes projects.”
And for those that are unsure whether certain workers are employees or independent contractors, the IRS is happy to help.
The request to have the IRS make the determination can be made by a firm or a worker, and is submitted on Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and income Tax Withholding.”