HARTMAN, BLITCH & GARTSIDE CERTIFIED PUBLIC ACCOUNTANTS

 

Employee or Independent Contractor

A company treated one of its workers ("Pete") as an independent contractor for 1995, and as a result did not withhold income taxes or FICA taxes from his wages. The company assumed that Pete would pay his own income taxes and self-employment (social security) tax. In fact, Pete did not pay the full amount of his income taxes.  The IRS later audited Pete, and determined that he was an employee and not an independent contractor (self-employed) in 1995. The ques­tion then was who was legally respon­sible for the underpayment of Pete's income tax? Pete claimed that his em­ployer was responsible for his income tax liability for 1995 because it failed to withhold these taxes from his wages when they were earned. Tax Court rejected Pete's argument and agreed with the IRS. In other words, the worker remains fully liable for income tax aris­ing from the receipt of gross wages. Therefore, even though the company misclassified John as self-employed and failed to withhold income taxes, he remained liable for his own income taxes for the year. The employer did however get fined penalties for failing to withhold taxes. The tax consequences for improperly classifying an employee as an independent contractor:  THE WORKER'S LIABILITY - If a employer treats a worker as self-employed who is later reclassified as an employee by the IRS, the worker remains liable for paying his or her own income taxes. If the worker fails to pay the correct amount of income, he or she cannot hold the employer liable for the unpaid taxes on account of the employer's misclassification and failure to with­hold the correct amount of taxes.  It is common for self-employed workers to underpay their taxes. One reason is that they spend the money and do not have it available to pay the tax. Another reason is unfamiliarity with how they should file and pay the tax. As a result, whenever a employer misclassifies a worker as self-employed, there is a risk that the worker will underpay his or her taxes.  THE EMPLOYER'S LIABILITY - The failure by an employer to withhold payroll taxes from a self-employed worker who the IRS later re­classifies as an employee has the following consequences:  the employer is liable for an "income tax" penalty of 1.5 percent of the employee's wages (3 percent if no 1099 was filed) the employer is liable for a "FICA" penalty of 20 percent of the employee's share of FICA taxes (40 percent if no 1099 was filed)  the employer is liable for the full employer's share of FICA taxes the employer is liable for the full amount of the employee's taxes if it intentionally disregards the withholding roles   EXAMPLE  -  Joan works part-time and makes $10,000 for the year. The employer treats Joan as self-employed, and she pays her income taxes and self-employment (social security). The employer issued Joan a 1099 form.  Joan's 1999 tax return is audited, and she is reclassified as an employee by the IRS. If Joan failed to pay the correct amount of income taxes for 1999, then she is responsible for the underpaid tax. The employer incurs a penalty of $1,068.  The penalty is made up of (1) 1.5 percent of Joan's wages  (2) 20 percent of Joan's share of FICA taxes (3) the full employer's share of FICA taxes of 7.65 percent). Even if Joan had paid the correct amount of taxes, the employer's penalty is the same If the employer did not issue Joan a 1099 form, penalties are increased to $1,674. If an employer decides to treat all employees as self-employed in order to avoid having to withhold taxes, this is considered intentional disregard, and the employer is potentially liable for all of its employees' taxes.