The number of natural disasters that have hit the United States in the last several years has caused many businesses to hire additional workers to help them meet increased demand for their goods or services. These businesses must classify their workers properly to make sure everyone can meet their tax obligations. 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 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 3509 provides an opportunity to correct the tax treatment of misclassified employees. Code Sec. 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. Code Sec. 3509 does not provide a reduced FUTA rate.
If the employee does not qualify for the reduced rates under Code Sec.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 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 requirements described in Sect. 530 of the Revenue Act of 1978, Publication 1976, Independent Contractor or Employee?:
- The employer must have had a reasonable basis for not treating the workers as employees.
- The employer (and any predecessor business) must have treated the workers and any similar workers as independent contractors for all applicable periods beginning after December 31, 1977.
- The employer must have filed Form 1099 MISC (Miscellaneous Income), for each worker, if such form was required.
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. (Social Security Administration/Internal Revenue Service Reporter, Fall 2006.)
Additional information available
For additional information on the worker classification issue, see:
- IRS Headliner 152, (http://www.irs.gov/businesses/small/article/0,,id=155756,00.html), IRS Offers Tips on How to Correct Misclassification of Employees.
- Publication 15-A, (http://www.irs.gov/pub/irs-pub/p15A_05.pdf) Employer’s Supplemental Tax Guide.
- Publication 1779, (http://www.irs.gov/pub/irs-pub/1799.pdf) Independent Contractor or Employee?