Tips For Reporting Misclassified Employees

Most employers make every effort to meet their employment tax obligations. They take the care to review all factors affecting their relationship with their workers and classify their workers as employees or independent contractors accordingly. Occasionally, an employer does make an error and classifies an employee as an independent contractor and has to correct that mistake.

When an employer does incorrectly classify an employee as an independent contractor, the employer is still responsible for paying the employee’s federal income tax withholding and the employee’s share of Federal Insurance Contributions Act (FICA)/Railroad Retirement Tax Act (RRTA), even if it was not withheld from the employee’s wages. The employer still must pay the employer’s share of matching FICA/RRTA and Federal Unemployment Tax (FUTA). Penalties and interest may also apply.

All of these payments can add up for the employer, but the good news is that the Internal Revenue Service does provide some relief for employers who have made a classification error. Internal Revenue Code Section (IRC §) 3509 provides an opportunity to correct the tax treatment of misclassified employees. IRC § 3509 provides reduced rates for the employee’s share of FICA taxes and for the federal income tax that should have been withheld. Employers are still responsible for the full amount of their share of FICA taxes. IRC § 3509 does not provide a reduced rate for FUTA.

If the employer does not qualify for the reduced rates under IRC § 3509, the employer may still be relieved from paying the federal income tax that should have been withheld from the employee. They need to provide evidence that the employee reported the income on their federal income tax return and paid the federal income tax due. The employer who requests this relief must have the employee sign a Form 4669 (Employee Wage Statement) stating that the income was reported and the taxes attributable to the income have been paid. The employer must complete and sign Form 4670, Request of Relief from Payment of Income Tax Withholding and submit this form along with any properly executed Form(s) 4669 to request for relief from payment of this tax liability. This does not relieve employers of any penalties or additions to tax for failure to withhold the tax.

However, an employer will not owe employment taxes for misclassified workers, if they meet all three of the following requirements described in § 530 of the Revenue Act of 1978, as amended.

If the employer meets the Section 530 requirements, the section provides businesses with relief from federal employment tax. It terminates the business’s, not the worker’s, employment tax liability (attributable to such workers) under Internal Revenue Code (IRC) Subtitle C (Federal Insurance Contributions Act (FICA)/Railroad Retirement Tax Act taxes, federal income tax withholding, and Federal Unemployment Tax Act (FUTA) taxes, and any interest or penalties attributable to the liability for employment taxes (Rev. Proc. 85-18, 1985-1 C.B. 518).

However, the Section 530 relief provision does not apply in the case of a worker who, pursuant to an arrangement between the business and a client, provides technical services for that client as an engineer, designer, drafter, computer programmer, systems analyst or other similarly skilled worker engaged in a similar line of work. (Section 1706 of the Tax Reform Act of 1986).


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