It is estimated that as much as $1.5 billion in income, Social Security withholdings and unemployment tax revenue is lost annually due to misclassification of as many as 3.5 million workers as independent contractors (source www.taxes.ca.gov ). That is a lot of money!
It is the IRS – as the federal taxing authority – that determines whether an employment relationship exists between a worker and employer requiring payment of federal employment taxes, including Social Security taxes, payment under the Federal Unemployment Tax Act and withholding of worker-owed employment taxes. The EDD is also involved when one of these “1099 employees” files an unemployment claim.
An IRS Form 1099-MISC is a method the government uses to track and report certain types of non-employment income. When a “1099” is provided to a worker for payment of services, it does not automatically make the worker an independent contractor nor does calling someone an independent contractor make him/her one in the legal sense. Employers that have “1099” employees or “contractors” working for them improperly classified are subjecting themselves to heavy penalties from the IRS.
The most important factor in that determination involves the independent contractor’s right to control the manner and means of accomplishing the desired result, even if the contractor does not exercise that right with respect to all details.
Before classifying an individual as an independent contractor, employers need to familiarize themselves with the many factors the different governmental agencies use to determine independent contractor status. Information regarding the laws governing the Independent Contract classification can be found at www.IRS.Gov
Misclassification of bona fide employees as independent contractors can result in the federal government collecting significant financial penalties from employers. The IRS is aggressively auditing companies to expose abuses.
All businesses or government entities required to file a Federal Form 1099-MISC for service performed by an independent contractor must report using Independent Contractors Report – DE542
For more information see Employer’s Supplemental Tax Guide (IRS Publication 15A), and California Employer’s Guide (DE 44) . The EDD will also assist employers in making a proper classification with an Employment Determination Guide form DE38 which is accessible at www.edd.ca.gov/pdf_pub_ctr/de38.pdf
I highly recommend employers seek legal advice when in doubt re 1099 employees.
Author: Robin Noah, Executive Coaches of Orange County, www.ECofOC.org