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Business owners are required to withhold federal, social security and Medicare taxes from employee paychecks and forward these funds to the Internal Revenue Service (IRS). This is not required for workers who fall under the classification of independent contractors. Because of this, employers are sometimes tempted to classify workers as independent contractors who are actually employees. It is important that you understand the difference between these two employment situations so you do not find yourself in trouble with the IRS.
Employee Classifications According to IRS Law
The IRS separates workers into four different categories. You must select the classification that is most appropriate among the following:
Consider Common-Law Rules When Choosing an Employment Designation
The IRS looks at the degree of independence workers have verses the amount of control that you have as the employer to determine how their employment should be classified. The following three factors play an important role in the decision-making process:
If you are still unclear whether to classify your worker as an employee or an independent contractor, you may complete the Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, which is IRS Form SS-8. The IRS reviews the information and notifies you of its decision within six months.
Potential Penalties for Classifying Employees as Independent Contractors
The IRS may hold you liable for employment taxes if you have classify an employee as an independent contractor when you had no basis to do so. Relief provisions may be available if you file the correct paperwork with the IRS.