This is always a sticky portion of Tax Law. I realize how unreasonable it is. But also please realize that this is one of the main ways that the various taxation agencies put entrepreneurs out of business.
Employee vs. Independent Contractor 20 Point Acid Test No Longer in Use
The old 20 Point Acid Test used to determine whether a worker can be treated as an Independent Contractor versus having employment taxes withheld as an employee is no longer in use at the Federal Level. Things have changed.
Generally speaking, if you are paying an entity such as Accounting Solutions Ltd. which is a company with an FEIN, then the relationship is independent. Taxes need not be withheld from those payments.
But if you are paying an individual with a social security number, other than the exceptions noted below, they are to be treated as employees with the applicable payroll taxes withheld and reported.
The individual circumstances are irrelevant. They can be part-time, high school students on a summer job, or the elderly; it doesn’t matter. You need to withhold taxes from those paychecks.
And please don’t act like some Independent Contractor Agreement drawn up by the Law Firm of Dewey, Cheatum, and Howe will matter. It won’t. The auditor won’t even look at it. You will be guilty and will be charged the withholding tax that you were supposed to withhold, plus interest and penalties.
Employee vs. Independent Contractor 20 Point Acid Test Exclusions
There are only seven exclusions provided in the law. Statutory Employees which are categorized as employees for Social Security and Medicare purposes only are described as…
1 – An agent or commission driver delivering food, beverages, laundry or dry cleaning for someone else
2 – A full time Life Insurance Agent or Investment Salespeople working on commission only
3 – A home worker who works on materials or goods a business supplies according to specifications that the business sets, who returns the finished work to the business
4 – A full time traveling salesperson working on behalf of one firm selling merchandise or supplies
Statutory Non-Employees where neither Income nor Payroll taxes are required to be withheld are described as…
1 – Direct Sellers
2 – Companion Sitters
3 – Real Estate Agents
New Definition of An Employee
Earlier last year, the Administration reaffirmed its stance that an employee was defined as, “Any individual working for any company in the US.” This is the broadest definition and position I’ve ever seen the Feds enforce.
The Administration then imposed further new rules in the continuing debate over whether or not a worker could be classified as an independent contractor. The rules impose even stricter tests in making the determination.
Whether or not a worker can be considered an Independent Contractor will now include the following questions…
1 – Is the job considered a permanent position or is it temporary?
2 – Does the employer have any control over how the work is performed?
3 – How integral is the worker’s job to the overall performance of the company?
Let me leave you with this.
During The Clinton Administration, the Social Security Administration ran dry. Congress had to pass an emergency funding bill so that the retirees would continue getting their monthly checks.
The Director of the Treasury then sat down with the Director of the Social Security Administration and asked why? The answer came down to all of the 1099 contractors who weren’t properly paying into the system. Those individuals who hadn’t paid anything in were now collecting benefits, bankrupting the system.
At that point we had a major shift in how the existing employment tax laws were enforced. The laws didn’t change, but how they were enforced did.
Prior to that point in history, we had the old 20 question acid test that would determine whether or not we could put a worker on a 1099. But that all changed in a heartbeat.
Now, in the event of an audit, the auditor won’t look at any of that. They look at the names on your checks. If those names are ABC Inc, DEF LLC, or whatever other company name we can imagine, then you’re in the clear. If those names are Jimmy, Jenny, or Joey and those people didn’t go through your payroll, you’re guilty.
Period. End of Story. Fahgetabadit. There are no arguments to be made. Trust me. I’ve tried.
What happens next? That depends on the level of government where the audit occurs.
If it’s at the Federal Level and you have as little as $100K in 1099’s during a given year that were miscategorized, they’ll hit you with 15.3% in Social Security and Medicare Taxes. Also you’ll be required to pay the Federal Withholding Tax that should have been withheld at let’s say 20%.
So far that’s a $35,300 tab, but they won’t stop there. They’ll open up two more years of income tax returns for audit just because they can.
If those results are similar to the first year, then your bill just became $105,900, but are they done yet? Of course not.
You’ll also have to pay penalties and interest. Sometimes that amount depends on how much you aggravated the auditor, but let’s estimate and say that the bill just became somewhere between $170K and $190K.
Don’t play these games. There’s no way to win. If you have questions or difficulties in this regard, please give us a call.
This is the twelfth column in my series to get my clients ready for their December Tax Planning sessions.
We’re all going to get through this. Let’s get through it together.
Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
773-267-7500
888-310-0300
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