Employers Beware – Misclassifying Workers

The Internal Revenue Service has developed a new form for employees who have been misclassified as independent contractors by their employers. Form 8919, Uncollected Social Security and Medicare Tax on Wages, will now be used to figure and report the employee’s share of uncollected social security and Medicare taxes due on their compensation.

Generally, a worker who receives a Form 1099 for services provided as an independent contractor must report the income on Schedule C and pay self-employment tax on the net profit, using Schedule SE. However, sometimes the worker is incorrectly treated as an independent contractor by their employer when they are actually an employee. When this happens Form 8919 will be used by workers who performed services for an employer but the employer did not withhold the worker’s share of Social Security and Medicare taxes.

In addition, the worker must meet one of several criteria indicating they were an employee while performing the services. The criteria include:

• The worker was previously treated as an employee by the firm and they are performing services in a similar capacity and under similar direction and control.
   
• The worker’s co-workers are performing similar services under similar direction and control and are treated as employees. 
   
• The worker’s co-workers are performing similar services under similar direction and control and filed Form SS-8 for the firm and received a determination that they were employees. 
   
• The worker has been designated as a Section 530 employee by their employer or by the IRS prior to January 1, 1997. 
   
• The worker has filed Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, and received a determination letter from the IRS stating they are an employee of the firm. 
   
• The worker has received other correspondence from the IRS that states they are an employee. 
   
• The worker has filed Form SS-8 with the IRS and has not yet received a reply. 

By using Form 8919, the worker’s Social Security and Medicare taxes will be credited to their social security record. To facilitate this process, the IRS will electronically share Form 8919 data with the Social Security Administration.

A completed Form SS-8 may be filed with the IRS by either the employer or an employee – with or without the knowledge or consent of the other party – to request a determination of the worker’s status as an employee. The IRS will only rule with regard to prior employment status, not on the individual’s prospective employment status as an employee or independent contractor. During the review of the information provided with Form SS-8, enough questions may be raised to result in an employment tax audit of the employer.

If it is determined in audit that the worker should have been treated as an employee and not an independent contractor, the employer may face some serious, and potentially expensive, consequences. In addition to having to pay the payroll taxes that should have been withheld, the employer must issue the employee a W-2 and revised Form 1099 for the years that are reclassified. The employer will also need to review any of its benefit plans to determine the consequences of the reclassification. For example, the employer’s qualified retirement plan could be disqualified because not all employees were covered.

While it may be tempting to classify a worker as an independent contractor to avoid paying the employer’s share of employment taxes or having to deal with the extra tax filings and paperwork that comes with employees, the consequences of having that person reclassified as an employee can be severe. Now that the IRS has provided employees with a convenient method to pay their share of the Social Security and Medicare taxes, and thus raise the “red flag” as to the classification, it is likely that the IRS will be more aggressive in following through with audits of the employers.

If you have any questions, please give this office a call.

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