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Are you an employee or a contractor?

By Kay Bell ·
Monday, March 29, 2010
Posted: 12 pm ET

While the odds of getting audited for individuals is pretty low -- the number has remained at less than 2 percent for years -- one group of filers is on the IRS examination list: businesses. 

It's no secret that the IRS is interested in small businesses, particularly those whose owners file Schedule C along with their personal returns. The tax office believes that many of these small operations regularly overclaim deductions and underreport income. Since there's rarely any third-party verification of transactions, it's hard for the IRS to verify claims on these returns, but it intends to keep the pressure on this group of filers.

Larger businesses also are coming under more IRS scrutiny. The tax concern here is that the firms are counting employees as contractors. Such misclassification often happens when times are tough as businesses use more independent contractors to cut labor costs.

But that also cuts the amount of revenue tax collectors get. When employees are misclassified as independent contractors, it often results in failure of the workers and employers to correctly pay income taxes, Social Security, Medicare and unemployment insurance taxes, notes accounting firm Einsner Lubin in a recent newsletter. 

Such tax oversights mean that Uncle Sam loses substantial money. 

How substantial? Obama's fiscal 2011 budget calls for $25 million to fund a joint Department of Labor-IRS effort to find workers who can be recategorized as employees. By doing so, according to the budget figures, the IRS could bring in an additional $7 billion over the next decade. 

What's the difference? There are several ways for employees, workers and the IRS to determine whether someone is an employee or a contractor.

The key test is what is known as behavioral control.

If the company has the right to control or direct not only what is to be done but also how it is to be done, then the worker is most likely an employee.

If, however, the company can dictate only the result of the work but not the means and methods of accomplishing the result, then the worker is probably an independent contractor.

Tipping off the IRS: Often a worker knows he or she technically should be carried on the company books as an employee rather than a contractor. But many don't want to risk losing any income, so they keep quiet.

The IRS, however, wants to hear from you if you're one of these workers. 

First, submit Form SS-8. This lets the IRS know that you believe you've been misclassified and by providing information about your work relationship, ask the agency to determine if you are an employee or independent contractor.

You also can file Form 8919. You report your half of Social Security and Medicare taxes that you paid on your improper independent contractor earnings via Schedule C and Schedule SE.

Once the IRS has this information on Form 8919, it can contact the employer for the other half that your employer should have paid. That way, your earnings and tax records will be up-to-date, and when you are eligible for these government benefits, you'll receive the appropriate amounts.

And by getting your employment status straightened out, in the long run you'll be doing yourself and the U.S. Treasury a favor.

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