So, what is a contract labor employee versus a W-2 employee? There is some ambiguity when it comes to making this determination. A good rule of thumb is that if the employer can control the work performed, such as where, when, and how it is performed, the employee probably should not be paid on a 1099.
Many small business owners deal with contract labor to one degree or another. Either they pay for contract labor or they hire contract laborers. When hiring others to perform work for you, it is smart to know when to qualify somebody as a contract labor, or 1099, employee.
So, what is a contract labor employee versus a W-2 employee? There is some ambiguity when it comes to making this determination. A good rule of thumb is that if the employer can control the work performed, such as where, when, and how it is performed, the employee probably should not be paid on a 1099. Once you, the employer, begin providing the equipment and requiring a work schedule, that employee should be a W-2 employee. Employers are required to withhold specific state and federally-regulated taxes for W-2 employees.
When employers are paying on a contract labor basis when an employee is a legitimate W-2 worker, they are taking risks that have serious IRS implications. If the IRS does an employment tax audit on your business, not only will you be hit with the penalties associated with the audit, but you will have to pay the withholding (tax, social security, and Medicare) that you should have withheld but didn’t.
Business owners who are in compliance might have an employee who is not in compliance. This can create a backlash at a future date. Employees with these non-compliance problems often cause an employee retention problem for the employer.
If employers have employees who are not in compliance, it is beneficial to make these contract employees aware that there is a process by which these issues can be remedied. This helps employers retain good employees while they work through their tax issues.
If you are or were a 1099 contractor and owe taxes for the last several years, typically you filed and owe money or you didn’t file and the IRS filed for you. If they filed for you then you have two problems. First, the amount you owe is daunting. Second, the daunting amount you owe is almost certainly incorrect. You can correct this by filing your own return to replace the one they filed for you.
What happens when the IRS is chasing you for the money? Generally, they will levy your employer, and since you are a contract laborer, that levy attaches to the employment contract and the IRS gets your entire paycheck. In contrast, wage levies on W-2 employees only attach to a portion of your pay.
What do you do? You quit your job and go to the next one. Then the IRS spends a few months or a couple of years and tracks you down which starts the process all over again. You are playing musical jobs just to keep getting paid. Truck drivers paid on a 1099 arrangement are especially famous for this tactic because there is no shortage of new employers to replace the one levied.
Employer problems of non-compliance
What if you are that employer? Maybe you didn’t know your new employee had a tax problem and you hire them, train them and come to rely on them, only to have them quit when the IRS issues a levy. There is a real cost to you when this happens as employee retention is a real expense. Now you are forced to send all of their pay to the IRS instead of the employee. Who wouldn’t quit under this scenario?
Difficult as the situation is, remember, the IRS takes these actions only because the taxpayer is out of compliance. If you can help your employee get back into compliance before the levy hits, then there will be no issue.
Get help now to get it fixed. The peace of mind is liberating. The IRS simply wants returns filed and/or a payment resolution established in order to solve the problem. Do not be fearful of the process. More often than not, the IRS payment is not only very low, but the taxpayer can end up paying nothing to the IRS on their back taxes. Not everyone qualifies for these programs, but this is a very common outcome.
Having the right representation when dealing with the IRS can be crucial in these matters. Thankfully, there are many experts around the country who can help the non-compliant employee fix these problems. Call one today!
By Ken Mullinax