The Importance of Classifying Workers

Recently, the IRS released a fact sheet to help remind small businesses of the importance of correctly classifying workers. Sometimes IRS lingo can be complicated, so we broke it down for you.

Let’s start with the question that’s probably going through your head – why does this matter?

When you classify your workers, this can help determine if you need to withhold income, social security and Medicare taxes. It also helps determine if you actually have to pay these taxes on employee wages. When it comes to independent contractors, businesses usually don’t have to withhold or pay taxes. If you’re not classifying correctly, you can get stuck with some harsh fines and penalties.

So how do you determine if the individual is an independent contractor or an employee? One general rule to follow is that your worker is an independent contractor if the business has the right to control only the result of the work, not how the work will be done. However, there are three categories that can help you make your determination.

Behavioral Control

A worker is considered an employee when the business gets to be bossy. Okay, maybe bossy isn’t the right word, but the business does have the right to direct and control the work being done. Behavioral control can be broken down into a few more distinct categories:

  • Type of instructions – This can include telling the employee where to work, when to do the work and how the work should be done.
  • Instruction complexity – The higher the complexity of the instructions given, the more likely it is the individual is an employee. When the instructions have less detail, this gives the worker more control to do the job how they see fit, which points towards the worker being an independent contractor.
  • Evaluation – How a business evaluates the work can help determine if the worker is an employee or contractor. If the details of how the work was done are evaluated, then the worker is likely an employee. However, if only the end product is being evaluated, it’s more likely you have a contractor.
  • Training – This one is fairly simple. Would you like someone else telling you how to do your job? If a worker is an employee, the business has the authority to do just that. For independent contractors, they are the experts and generally don’t require training from the hiring company.

Control over Finances

This category looks at what control the business has over the financial and business pieces of the worker’s job. Factors to consider include:

  • Equipment investment – Independent contractors are much more likely than employees to make significant investments in the equipment they are using to get the job done. Employees are often provided equipment from their employer, rather than investing in it on their own.
  • Expense reimbursement – Businesses generally reimburse expenses for their employees, not for independent contractors.
  • Availability – Independent contractors generally have the freedom to seek out more business opportunities, while employees work is usually contained to the one business.
  • Payment – This one is easy to understand. When you have employees, you usually guarantee them a regular wage. With independent contractors, a flat fee is usually agreed upon and paid on the completion of the work.

Relationship Elements

What the business or worker offers in the relationship can also determine classification. Some key elements to consider are:

  • Contracts – Written contracts which describe the relationship the parties plan to create are a fairly simple way to determine which type of worker the business has. However, it’s important to note that a contract stating the worker is a contractor or an employee isn’t enough on its own to classify the worker’s status.
  • Benefits – Insurance, retirement, vacation and sick pay are benefits provided to employees. It’s rare for these benefits to be given to independent contractors.
  • Forever or just a fling – The length of time of the relationship can help determine a worker’s status. When an employee is hired, the expectation is that the relationship is long term. For contractors, the relationship isn’t permanent. Instead, both parties enter the relationship with the assumption of a certain amount of time for the work to be completed.

When businesses wrongly classify their workers, they are still liable for the related taxes and payments for those workers, and may even face other sanctions. Correctly classifying your workers helps you avoid this, making it easier for you to run your business.

We know this stuff can be kind of confusing – and even scary. But don’t fear! We are here to help.. just ask!

 

Forms W2 & 1099: What You Need to Know

w2-bookAs 2017 begins, one of the things at the top of a business owners list is forms. Tax forms, to be more specific.

These forms are complex and take some time to go through. However, they’re necessary for your business for a multitude of reasons, one of which is not getting in trouble with the IRS.

Two of the most common tax forms you’ll get to deal with are the W-2 and 1099. These particular forms deal with reporting worker wages and income … and employees like to get paid.

Need a refresh on what they are? Check it out here and here.

To learn more about these important forms, and how to complete them correctly, check out our annual W2/1099 Book. In it, you’ll find:

  • Answers to who is an independent contractor and who is an employee
  • Information specific to the 1099
  • New Hire Reporting requirements and info
  • Information specific to Forms W-2 and W-3

Check out all the goodness here.

Year-End Planning: Form 1099

Now that you’ve become an expert in filling out your W-2s correctly (still not quite sure? Here you go!), it’s time to talk about another type of FORM. Get excited.

Form 1099

Businesses make certain payments to nonemployees during a calendar year. When they do this (you guessed it), they must furnish annual information returns both to the IRS and to the nonemployee recipient of the payment.

As a reminder, an information return is a document used for reporting purposes based on certain transactions incurred throughout the year. Information on these forms is used to assist both the taxpayer (you and the nonemployee party) in preparing to file taxes, as well as the IRS to match records to the taxpayer’s tax return.

In order to facilitate the reporting of these payments, IRS has developed the Form 1099 Series, which is a group of forms used to report ordinary kinds of payments made by a business, such as dividends, interest, retirement distributions, and miscellaneous income payments.

Wait … what?

While W-2 reports wages, salaries and tips, Form 1099-MISC, “Miscellaneous Income” is filed by a business for certain payments made to nonemployees (remember the difference?) in the course of trade or business.

What exactly does trade or business mean?

Trade or business generally refers to an entity that operates for gain or profit. However, it’s not that simple. Nonprofit organizations are also subject to these reporting requirements. Other organizations/items subject to the reporting requirement also include:

  • Trusts of qualified pension or profit-sharing plans of employers
  • Certain organizations exempt from tax under section 501(c) or (d)
  • Farmers’ cooperatives exempt from tax under section 521
  • Widely held investment trusts
  • Payments made by federal, state or local governments

When is Form 1099-Misc required exactly?

Form 1099 is required in a number of circumstances, including:

  • $10 or more in royalties or broker payments in lieu of dividends or tax–exempt interest;
  • $600 or more in:
    • Rent
    • Services, including parts and materials
    • Prizes and awards
    • Other income payments
    • Medical and health care payments
    • Crop insurance proceeds
    • Cash payments for fish you purchase from anyone engaged in the trade or business of catching fish (we’re not kidding)
    • The cash paid from notional principal contract to an individual, partnership, or estate
  • Any fish boat proceeds (again, not making this up)
  • Gross proceeds to an attorney
  • Reporting of direct sales of at least $5000 of consumer products to a buyer for resale anywhere other than a permanent retail establishment
  • Any backup withholding regardless of the amount of payment.

This form is seriously required? 

Yep! The form is required for each person to whom payments have been made during the year.

So everyone has to fill this thing out?

Not quite. There are certain payments where Forms 1099 are not required:

  • Generally payments to a corporation
  • Payments for merchandise telegrams (yes, it’s a thing), telephone, freight, storage and similar items
  • Payments of rent to real estate agents
  • Wages paid to employees (report on Form W-2. Learn more about that one here)
    • Other items not included on Forms 1099, but are included on W-2:
      • Military differential wage payments made to employees while they are on active duty in the Armed forces or other uniformed services
      • Business travel allowances paid to employee (may be reportable on W-2)
      • Cost of current life insurance protection (report on Form W-2 or Form 1099-R, Distributions from Pensions, Annuities, Retirement, or Profit-Sharing plans, IRAs, Insurance Contracts, etc.)
  • Payments to a tax-exempt organization including tax-exempt trusts (IRAs, HSAs, Archer MSAs, and Coverdell ESAs), the United States, a state, the District of Columbia, a U.S. possession, or a foreign government
  • Payments made to or for homeowners from the HFA Hardest Hit Fund or the Emergency Homeowners’ Loan Program or similar state program.
  • Payments made with a credit card or payment card and certain other types of payments, including third party network transactions
    • These ones go on a different form, known as the Form 1099K
  • A payment to an informer as an award, fee, or reward for information about criminal activity
    • Yep, you don’t have to fill this form out if you were being a good Samaritan, as long as the payment is made by a federal, state, or local government agency, or by a nonprofit organization exempt from tax under section 501(c)(3) that makes the payment to further the charitable purpose of lessening the burdens of government.
  • Scholarship or fellowship grants. Why, you might ask. Well scholarship or fellowship grants are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant.
    • So where might this one go? If you guessed W-2, you’re exactly right. They are considered wages and must be reported on Form W-2. Other taxable scholarships or fellowship payments (to a degree or non-degree candidate) are not required to be reported to the IRS on any form.
  • Difficulty-of-care payments that are excludable from the recipient’s gross income are not required to be reported. Difficulty-of-care payments to foster care providers are not reportable if paid for not more than 11 children under age 19 and not more than six individuals age 19 or older.
  • A canceled debt is not reportable on Form 1099-MISC. That one goes on a different form (yes, there really are a lot of forms), known as Form 1099-C.

This makes NO SENSE. Head hurts.

Tax reporting is complex and multi-faceted. This stuff isn’t easy and, frankly, stumps quite a few of us (and we’re accountants). So don’t be afraid to ask.

 

 

 

Year-End Planning: Who is an employee?

In case you hadn’t guessed it, it’s tax planning season (seriously though, we’ve mentioned it here and here). With this year-end planning comes a need to look at the reporting requirements related to your organization and its employees.

The IRS is a BIG fan of forms and there are several reporting requirements you’ll need to consider as you come to year-end and tax time. We’ll dive into some of the more specific forms in later blogs, but for now we want to take the opportunity to address a vital question you need to answer in order to begin your fantastic form filling journey.

That question is: Do you have employees or independent contractors?

Seriously?

Yep. The business relationship between the organization (you) and the person performing the services must first be analyzed to determine how payments should be treated.

Fine, tell me more.

An employee-employer relationship is generally determined by the “common law” test. The common law test focuses specifically on determining who has the right to control two basic elements:

  1. What must be done – i.e., the results of the work
  2. How it must be done – i.e., the method by which the work or services are performed

A worker is considered an employee (and subject to payroll tax withholding) if the employer has the right to control both aspects of the test. In other words, the employer controls both the results of the work AND how it must be performed.

A worker is considered an independent contractor if they can only control or direct the result of the work and not the method used to accomplish it.

Common law test

Are there other factors that can be used?

The IRS uses three categories when determining employee status and the degree of control and independence:

  • Behavioral control: factors that illustrate there is a right to direct or control how the worker performs specific tasks in which he/she is engaged. These include: significant degree of instruction, an evaluation systems to measure and ongoing training.
    • If these items are present, it generally points to an employer/employee relationship.
  • Financial control: factors that illustrate a right to direct or control the economic aspects of a worker’s activities. These include: does the person have a significant investment in the facilities or tools used in performing the service? Does the worker choose to incur expenses and bear their cost impact? Does the worker make themselves available to the general public?
    • If the answer to any of these questions is yes, they must be treated as an independent contractor.
  • Relationship of the parties: how do the worker and the business perceive each other in terms of their intent concerning control? Factors include: intent of the parties/written contracts, providing employee benefits, permanency of the relationship and if an individual’s services are a key aspect of the regular business of the organization.

 Seems pretty straightforward. But I’m guessing it’s not …

You’re correct. The common law test can be difficult to apply to specific cases or situations. Proper application of the test requires an employer to consider several factors of the work to determine if an employer-employee relationship exists.

Let’s break it down. The two primary characteristics that typically indicate an individual is an employee are:

  1. The employer has the right to discharge the worker
  2. The employer supplies the worker with tools and a place to work.

On the other hand, individuals such as lawyers, physicians, and contractors who offer services to the general public in the pursuit of an independent trade, business, or profession normally are not considered employees.

In case you hadn’t guessed it yet, it’s still not this simple. No one set of factors is the supreme answer. All the facts and circumstances in a particular situation have to be taken into account in determining whether an individual is an employee or an independent contractor. If you find yourself second guessing whether or not to treat someone as an employee or an independent contractor, Form SS-8 (yay forms!) can be filled out to assist in the decision.

Why do I need to figure this out again? Can’t I just ignore it?

Nope. Determining what type of individuals you’re using is necessary for filling out tax forms. If you have employees, their payments will be reported on Form W-2. If you have independent contractors, they’ll be reported on Form 1099-MISC.

Don’t worry, we talk more about these two forms here and here.