One of the biggest challenges for any business, whether new or established, small or larger, is hiring.
It's also a challenge for the Internal Revenue Service, especially when companies don't understand or intentionally avoid employment taxes.
Money lost from unpaid payroll taxes, both unreported or underreported, is huge, notes a recent Kiplinger's Tax Newsletter, accounting for a large portion of the overall federal Tax Gap. This is the amount of money the IRS is owed, but hasn't been able to collect.
Kiplinger cites IRS data from 2019 that found $77 billion of payroll taxes fell through the cracks yearly from 2011 through 2013. More than half of that amount was from self-employment taxes.
Employment tax carrots and sticks: That's why the IRS has stepped up its employment tax efforts, using both enforcement and outreach.
On the enforcement side, the agency and Department of Justice are increasing investigations into schemes used by small businesses and their owners to avoid payment of employment taxes.
On the outreach side, especially during this year's National Small Business Week sponsored by the Small Business Administration, the IRS is working to get the tax word out about employment and other business tax requirements.
Income and FICA tax collections: When a business hires staff, it has some tax tasks to complete in connection with those workers. The most notable is withholding income taxes, both federal and state.
A close second is payroll taxes mandated by the Federal Insurance Contributions Act, or FICA. These taxes, paid equally by employers and employees, go toward funding Social Security and Medicare.
The total Social Security tax is 12.4 percent, split evenly between the two tax sources every pay period. The Medicare portion is 2.9 percent, again divided with boss and worker paying half each out of each paycheck.
The combined tax total of these two retirement-focused federal programs comes to 15.3 percent. Again, 7.65 percent comes from the worker's pay and 7.65 percent is matched by the employer.
Misclassified workers: When companies misclassify workers as independent contractors instead of as employees, the employer's share of taxes is not paid, and the employee's share is not withheld.
The worker then is responsible for the FICA taxes, by making self-employment payments as part of their estimated taxes, which also cover the income tax component.
Sometimes a company makes an honest mistake in calling a worker a contractor. Other times, it's a deliberate attempt to avoid paying the business' portion of FICA taxes.
If a business misclassifies an employee without a reasonable basis, it could be held liable for employment taxes for that worker.
IRS assistance in determining work status: Workers who believe they have been improperly classified as independent contractors can turn to the IRS for help.
First, they should file IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. This officially asks the IRS to settle whether they are employees or independent contractors for tax purposes. Companies can also file such requests to clarify a worker's employment status.
Read about more IRS tax forms
Workers who believe they were improperly classified as contractors and therefore did not have FICA taxes withheld also can file Form 8919, Uncollected Social Security and Medicare Tax on Wages. This will help the worker and IRS to figure and report their share of uncollected FICA amounts on their compensation.
Control is a main issue: For tax purposes, a worker generally is considered an employee if the business can control what will be done and how it will be done.
In making that decision, three categories typically are examined, and questions about them are part of SS-8. They are:
- Behavioral Control − Does the company control or have the right to control what the worker does and how the worker does the job?
- Financial Control − Does the business direct or control the financial and business aspects of the worker's job. Are the business aspects of the worker's job controlled by the payer? This is things like how the worker is paid, whether expenses reimbursed, and who provides the tools and supplies used to do the job.
- Relationship of the Parties − Are there written contracts or employee type benefits, such as a pension plan, insurance, vacation pay, etc.? Will the relationship continue and is the work performed a key aspect of the business?
If you're working as a contractor, but believe that the above considerations mean you should be classified as an employee, discuss it with your employer. If y'all can't reach agreement, then you can turn to the IRS for help.
'Fessing up to misclassifications: If, on the other hand, you're a business and you realize that you've misclassified workers, you need to make it right with them and the IRS as soon as possible.
The IRS' Voluntary Classification Settlement Program (VCSP) is an optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes. It also provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees.
Business taxpayers must meet certain eligibility requirements; apply by filing Form 8952, Application for Voluntary Classification Settlement Program; and enter into a closing agreement with the IRS.
Businesses can find additional information at the IRS' small business taxes virtual workshop. This is nine interactive lessons designed to help new small business owners learn their tax rights and responsibilities.
You also might find these items of interest:
- Tax implications of business entity choices
- Paying self-employment taxes on the revised Schedule SE
- Employee or contractor? The IRS has some guidelines on when each work status applies