The Tale of the Misclassified Worker
I don’t know if I’m just the lucky one to be seeing this or if it’s a trend across the nation, but people are often being misclassified as contractors.
For most of my 23-year career, barring the last few, I had only filed a handful of Form SS-8s. This is the document you file with the IRS to have them determine whether a taxpayer is an employee or a contractor. I must have filed at least 20 in the past three years.
In view of this growing trend, I think it might be time to review the rules of who is an employee and who isn’t.
I use an analogy with my clients when I am trying to prove a point about contractors and employees. I tell them that I am a contractor, and you pay me for a service. However, you don’t have any control over how I provide that service. You don’t expect me to be in your office at 9 a.m., for example. You don’t direct my work schedule or my work.
Being an employee boils down to control over the worker. Does the worker work a set number of hours? Do you direct them? Does the worker use your tools or equipment? If any one of these questions is confirmed, then the worker is probably an employee.
My assistant works a certain number of hours. I direct her. She is required to be at the office at a certain time, and she works until a certain time. She uses a computer and a desk that I provide. In a nutshell, she is my employee.
My bookkeeper, however, works her own hours. I direct her only to the extent that I check her work. I pay her a percentage of what she bills. She works in another state and uses her own computer. I provide her with the software to use. She has her own business where she offers bookkeeping services. She is not my employee; she is a contractor.
Do you see the difference? Do I have control over the bookkeeper? Only to the extent that I check her work. The key is that she has her own business where she provides the same services to other people.
What I see happening is that employers don’t want to pay the other half of Social Security and Medicare or unemployment. Further, they don’t want to open employee benefits to all their employees. What they are doing is paying them as a contractor when the person is actually an employee.
As the arrangement goes, the worker isn’t paying any taxes and the employer doesn’t have to pay taxes. Everything is fine, until the worker has to file her income tax return and she realizes that she is responsible for both sides of FICA. The worker sees how much tax she owes and she doesn’t want to pay it. Is this person an innocent victim? Hardly. She went along with the arrangement, all year no less.
As a preparer, we sometimes must play detective. When I see a 1099-MISC for a client who in past years was a W-2, I start asking questions. When did he become self-employed? What did he do to earn the money reported on the 1099? Usually, this person ends up being an employee, but instead he was treated as a contractor.
What you need to do is claim the amount of the 1099 as wages. Your client is responsible for half of FICA. Then you fill out Form SS-8 and send it in with the return.
What happens then is that a full employer audit from the IRS ensues. You would think that your client would get fired for blowing the whistle, but that won’t happen. The filing of Form SS-8 is done anonymously. The employer never knows who files the form and they probably have treated several employees the exact same way. Filling out the SS-8 ensures that it’s the employer left holding the bag.
I used to feel sorry for the employers I targeted, but I don’t anymore. On one hand, I totally get it. I wish that I could save employer tax. However, these employers should have gotten professional advice before they set up this scheme. Had they talked to me, I would have told them that they were misclassifying their employees. The fee that they would have paid me would have been far less than the penalties that they are on the hook for.
The moral of the story is: Don’t accept what your clients give you without asking questions, especially if they are being treated a completely different way than they have in the past.
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...