SPS Email Alert
Dear Clients and Friends:
In light of renewed attention and legislation surrounding the classification of workers, we want to share with you some important information. Determining whether someone you hire (or someone who provides services) is an employee or an independent contractor is crucial for every business. The decision can have significant tax, legal, and business implications. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker, as well as significant interest and penalties. In addition, there may be insurance, benefits, and other considerations (costs) to comply. So, making the correct decision is important.
If you determine that certain individuals are independent contractors, please be sure you file 1099 forms reporting the payments. Your deductions for these payments can be disallowed if 1099s are not timely filed. In addition, consider the use of an independent contractor agreement spelling out the arrangement, and be sure to obtain invoices for all payments and maintain documentation supporting the independent contractor status.
The taxing and other authorities are placing renewed interest and focus on the status of workers and scrutiny is increasing. We want to bring to your attention a few matters regarding these issues:
IRS Voluntary Classification Settlement Program
A new program is available allowing businesses a “fresh start”. This voluntary settlement program is for eligible businesses that have consistently treated a class of workers as independent contractors (not as employees), have filed all required 1099 forms for the workers for the past three years, and are not currently being audited. A participating business will be required to agree to prospectively treat the class of workers as employees and will not be subject to employment tax audits for prior years.
So what is the catch? First, the IRS has to verify eligibility and accept you into the program.
Second, there are no current programs at the state level, so significant costs may result due to state taxes. Also, this doesn’t stop other federal agencies such as the Department of Labor from examining the company. Finally, the business must pay a fee of 10% of the employment tax liability that may have been due to compensation to workers for the most recent year. This fee should roughly approximate about 1% of the compensation that is being reclassified. While this may seem to be a relatively inexpensive way to come clean, there are many collateral issues to consider (back unpaid overtime, meal and rest break penalties, insurance and pension benefits that may be due, and others).
California Senate Bill 459
Effective January 1, 2012, penalties will be increased against employers who “willfully” misclassify as independent contractors individuals who should be treated as employees. Large civil penalties can be imposed and employers found to have engaged in these actions will be required to display notice of having committed a serious violation. As is often the case with new legislation, there is uncertainty with the language of the law in the area of what it means to have voluntarily and knowingly misclassified the status of the worker.
Employment Development Department Reporting
Businesses are required to report each year to the California EDD within 20 days of paying an individual $600 or more for services. This reporting is separate from and in addition to 1099 forms. While not widely known, this requirement to file Form DE 542 has existed for many years and penalties can result from not filing the forms.
Finally, though the focus of this alert is for businesses and the classification of workers, there are similar issues for employers of household workers. While caregivers and housekeepers may be considered as family members, the formalities of payroll taxes, workers’ compensation insurance, wage and hour laws, etc. must be addressed.
Please note that this alert contains general information and is not a complete analysis you should rely on in making decisions. Our goal is to bring these matters to your attention and suggest that you review your payments and practices. We are here to assist you. These may be difficult issues to address, and you may need to consult with your legal counsel as well.
Shareholder, Tax Department