The IRS has publicly stated it plans to crack down on organizations that improperly classify workers as independent contractors instead of employees. Are you confident your employee classifications would stand up to IRS scrutiny?
Understand the Requirements
The first step is to understand the requirements.
If a worker is an employee, your nonprofit must provide a Form W-2 annually and withhold income tax and the employee’s portion of Social Security and Medicare taxes from the employee’s pay. You also must pay the employer portion of Social Security, Medicare and unemployment taxes on the employee’s wages.
If a worker is an independent contractor, your organization generally should provide a Form 1099-MISC, which reports the amount you’ve paid to the person that year. The independent contractor is responsible for paying employment taxes (both the employee and employer portions) and income taxes on his or her own.
While the IRS generally should receive the same amount of total income and employment taxes regardless of whether someone is an employee or an independent contractor, the agency has found that it’s more difficult to collect from independent contractors. Thus, the IRS tends to favor employee status.
Should the IRS determine you’ve improperly classified an employee as an independent contractor, you may be held liable for that worker’s applicable employment taxes.
Take the Test
To determine whether a worker is an employee or an independent contractor, you must consider your nonprofit’s degree of control and the person’s level of independence. The IRS has assembled a number of questions to help employers decide. In the past a “20-factor test” was used to evaluate workers. These factors have recently been compressed into three general categories: behavioral control, relationship of the parties, and financial control. These categories are referred to as the “common law rule.” The questions revolve around:
- Whether your organization has the right to control the individual and how that person performs his or her duties (that is, behavioral control)
- Whether there’s a written contract between the individual and your nonprofit, and if the person receives employee benefits (that is, type of relationship)
- Which aspects of the business relationship your organization controls (that is, financial control)
Organizations must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that determines whether the worker is an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.
The final determination is to evaluate the entire relationship, consider the degree or extent of the right to direct and control, and finally, it is important to document each of the factors used in coming up with the determination.
Let the IRS Help
If you’re unsure whether an individual should be classified as an employee or an independent contractor, you can complete Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” and the IRS will decide for you. The process is free, though it might take six months or more to receive the determination.
Organizations that inadvertently misclassify an employee as an independent contractor may be able to mitigate the consequences under the IRS’s Voluntary Classification Settlement Program.
Need Help?
The IRS has reported that it loses millions in unpaid taxes and uncollected penalties for misclassified workers each year — and is looking to get it back.
Our Nonprofit Group can help you determine whether your nonprofit is following the rules. Contact us online or call 800.899.4623.
