IRS Sets Important Distinctions Come Tax Time
Washington, D.C. – The self-employed contribute a mighty portion to the U.S. economy – nearly $1 trillion. There is no question that they are helping create jobs by growing and hiring new workers. The question is, by hiring additional workers, are micro-businesses (those with 10 or fewer employees) actually creating more paperwork for themselves?
“Unfortunately, there always seems to be more paperwork required as the business grows,” says Keith Hall, National Tax Advisor for the National Association for the Self-Employed (NASE). “Knowing whether a new worker is an employee or an independent contractor is critical in knowing exactly what paperwork is required.”
As businesses grow, many owners find the need for new workers to help manage the needs of new and existing clients. At that point, it is extremely important to know the classification of those new workers and to make sure you pay them correctly and then report those payments correctly to the IRS at the end of the year.
Many small businesses believe that the classification of each new worker as either an employee or an independent contractor is simply a matter of choice. Not so, says the Internal Revenue Service (IRS). The IRS actually uses a multi-step checklist to evaluate whether a new worker is an employee or an independent contractor. If you are unsure whether to classify your newest worker as an employee or an independent contractor, here is a quick way to sort them out:
- If you control the Who, Where, When and How the work is done, then they are probably an employee. This means that you, as the business owner, must file a Form W2, withhold income and payroll tax, and potentially contribute to their retirement plans.
- If the worker controls their own work product and even has other customers besides you, then they are most likely independent contractors. Payments to independent contractors are reported on IRS Form 1099, and the independent contractors are responsible for their taxes and their own tax forms, including Schedule C, Profit or Loss from Business and Schedule SE, Self Employment Tax.
“It’s very important to do your homework and to make a good determination of the correct classification for each of your new workers. If you incorrectly classify workers, the IRS can come in later and reclassify payments you have made, which could potentially lead to penalties and interest if taxes were underpaid,” adds Hall.
If you are concerned that you may have misclassified workers in the past, don’t worry. The IRS has developed the Voluntary Classification Settlement Program in order to provide an opportunity for taxpayers to get things right and potentially avoid penalties that they may otherwise have to pay. Visit IRS.gov for more information.
The National Association for the Self-Employed (NASE) also offers micro-business tax advice from certified public accountants through TaxTalk. Submit your question and receive an answer from qualified CPAs at the NASE’s Tax Resource Center.