Subcontractors vs Employees - Digit Payroll
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Subcontractors vs Employees

Subcontractors vs. Employees


New Form Subcontractors (employees?) can file with the IRS

Employees, or more appropriately subcontractors, who feel they were misclassified as subcontractors and feel they should be employees can now tell the IRS. Form 8919, can be filed with the IRS, by the subcontractors. This form gives the IRS information regarding their employers.

The benefit to the subcontractor is that they may not have to pay the employer portion of the Social Security and Medicare tax. The agency may now have more leads in order to audit businesses for payroll tax issues. Currently the IRS has made a push to target more taxpayers, in which they have believed have misclassified workers as subcontractors.

The bottom line is more taxes are usually paid as a worker rather than a subcontractor. The IRS and Congress both recognize this. Congress is working on reforming the worker classification rules to make it easier for the IRS to go after these firms.


IRS Guidelines on Employee vs. Subcontractor


The following link gives some IRS guidance on the issue of employee vs. subcontractor.

IRS Independent Contactors vs. Employees

Some Tips to Avoid The IRS Reclassifying your Employees as Subcontractors

Create a contract that makes contractors not eligible for benefits offered to employees.  Pay contractors on a per-project basis not hourly.  Don’t restrict their ability to market their services.

Obtain contractors employer ID numbers along with business names and addresses.  Keep business cards, letterhead, or anything else that prove they work independently.

Don’t give them employee handbooks, or company email addresses.  Pay them only after they submit a bill.  Don’t invite them to company social events for employees.


How Does the IRS Identify Misclassified Employees?

The IRS shares information with most states.  If a state examines your payroll tax returns, it may share the results of the examination with the IRS.  The IRS matches Form 1099’s with businesses and the subcontractors.  If a business issues 5 or more 1099’s, for $25,000 or more and the recipients have no additional income, this could generate an audit.  As mentioned above, the new Form 8919, which allows subcontractors/employees to notify the IRS that they may have been misclassified is also a source of audit information for the IRS.


New Jersey Gets Tough on Workers Classification Rules


In the spring of 2007, New Jersey released new worker classification rules. These rules were already in place for Department of Labor purposes but not for income tax purposes. The new guidelines purport that you are guilty unless proven innocent. In other words, all workers are employees unless they can pass the “ABC” test.

The following is an except form the NJ release:

Gov. Corzine signed legislation that creates a common definition of an independent contractor. The legislation, effective January 1, 2007, standardizes the requirements for independent contractors, including conditions for coverage under the Unemployment Compensation Law and withholdings for the New Jersey Gross Income Tax.

A worker who meets requirements of the “ABC test” is considered an independent contractor. Prior to this legislation, the Department of Labor and Workforce Development used the ABC test to determine a worker’s independent contractor status, while the Department of Treasury – Division of Taxation used its own standard. The new legislation requires both agencies to use the ABC test.

In short, the ABC test considers all workers employees unless they meet all three parts of statute 43:21-19(i)(6)(A)(B)(C). According to part A, if the employer exercises control and direction over the worker — telling the worker what to do and when to do it, setting specific timelines, training the worker, etc., — the worker is considered an employee.

Part B states that unless the services are performed either outside the location where the business operates or are outside the usual types of services the company provides, the worker is considered an employee. For example, a carpenter hiring another carpenter is not considered outside the usual course of business.

Under part C, if the worker cannot prove that they have established their own business, the worker is considered an employee.

A worker must meet all criteria to be considered an independent contractor.

One of Gov. Corzine’s earliest initiatives directed the Department of Labor and Workforce Development to work with the Division of Taxation to tackle the escalating problem of employers who misclassify their workers. Employers who engage in this unlawful practice attempt to reduce their costs by classifying workers as independent contractors rather than employees. Employers are required to provide unemployment and disability coverage, workers’ compensation, social security coverage, and to make deductions for gross income tax for employees — but not for independent contractors.

According to Corzine, employers who misclassify workers gain an unfair advantage over competitors and hurt employers who play by the rules.

A standard definition of independent contractor allows the Division of Taxation to use audit information from LWD (NJ Department of Labor) to make its tax assessments, which is estimated to result in an additional $5 million collected annually for gross income taxes.