In a challenging economy, the Tax Resolution Institute has seen companies attempt to cut costs by choosing to distinguish workers as 1099 independent contractors instead of W2 employees. If IRS and state guidelines are not followed, however, business owners can find themselves in a world of trouble. As a result, since Payroll Tax Problems can be so extreme, the Tax Resolution Institute wants to help you clarify this situation. We will provide you with the information you need to make the right decision that will help you avoid the payroll tax problems of misclassification.
The Payroll Tax Choice — W2 vs. 1099
The choice between 1099 and W2 determines whether an individual is an independent contractor or an official employee. 1099 indicates Independent Contractor (IC) status, meaning that a business has less liability for the contractor’s acts and less ability to control how the work is done. W2 indicates “employment” status. As a result, a company can determine the time/methods/means by which work is executed. In addition, your company has greater liability for a worker’s actions and potential negligence. But it must be done correctly or serious unpaid payroll tax problems can arise to hurt your business.
This type of misclassification is one of the most contested payroll tax issues that businesses consistently have with the IRS. While you might like the simplicity of the independent contractor status for your employees, if they really are your employees, you are required to put them on payroll, giving them a Form W2 at the end of the year. Misclassifying an employee is the same as not paying your payroll taxes and is considered a serious offense by the Internal Revenue Service and the California Employment Development Department.
It is important to classify a worker as either an employee or an independent contractor (1099) to avoid IRS penalties for not properly withholding and paying FICA and payroll taxes. The IRS takes extreme action against employers whom they catch avoiding unemployment taxes and delaying tax collection. Additionally, California has hardcore rules as to when employers must pay into state unemployment funds and carry workers compensation coverage.
When done improperly, misclassifying workers as independent contractors can lead to serious problems and consequences. If the individual really is doing the work of an employee, the Internal Revenue Service or the California Employment Development Department might reclassify the individual as an employee, erasing the presumed financial benefits. In addition, your company will be charged interest and penalties. If you are caught willfully avoiding payroll taxes, criminal charges and the 100% trust fund recovery penalty can come into play as well.
Caution — The IRS Is Watching You!
TRI believes most important issues to consider are “Degrees of Control”, and who dictates when where and how? Does the employer direct and control how the work is done? Are instructions provided and is training given? These questions help to define degrees of control. Employees are subject to instructions and rules about when, where and how they work while an independent contractor generally is free of such restrictions.
The tax and additional consequences of misclassifying an employee as an independent contactor are costly and can also include paying both the employer and employee’s share of Medicare and Social Security, paying federal income taxes and state income taxes that should have been withheld, and paying federal and state unemployment benefits. All of these payments do not include the possible interest and penalties mentioned above. Unpaid payroll taxes are a serious problem.
If you want to treat an individual as an independent contractor rather than employee, structure the relationship appropriately. We can help your company avoid payroll tax problems with the IRS and payroll tax problems with the California Employment Development Department. In this recessionary economy, there is no reason to make tough times worse by mismanaging this essential part of tax planning.
If your company is in trouble when it comes to your unpaid payroll tax payments and you need help, contact the tax experts at the Tax Resolution Institute today.
