The costs of doing business are higher for businesses which treat their workers as employees rather than independent contractors. For example, employers must pay 7.65% of employee wages as payroll taxes, and must also withhold income taxes on employee wages.
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How the IRS Classifies Workers for Federal Employment Tax Purposes
Many businesses treat their workers as independent contractors, but discover when they are audited by the IRS that the IRS disagrees, and wants to reclassify the workers as employees. The IRS generally uses a facts and circumstances approach to determine whether workers are employees or independent contractors under federal common law. This is sometimes referred to as the 20 factor test and is set forth in IRS Revenue Ruling 87-41, 1987-1 C.B. 296. The test can be confusing to apply, and very difficult to predict the outcome. For that reason, if there are substantial dollars involved, expert representation is best.
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Businesses Have A Secret Weapon They Can Use To Fight IRS Reclassification Of Workers As Employees.
Section 530 of the Revenue Act of 1978, as amended ("Section 530"), allows workers who are admittedly employees to be treated as independent contractors if certain tests are met. These safe harbor rules do not apply to technical service workers such as engineers, computer programmers and others providing similar services to a company through an intermediary, such as an employee leasing firm. Furthermore, they apply only to employment tax provisions. Thus, for example, a worker may still have to covered under the company's pension plan. California has no provisions similar to Section 530. Therefore, it is not uncommon for workers to be classified inconsistently for federal and state purposes.
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How to Qualify Under Section 530
To be entitled to the protections of Section 530, a company must show that: (1) for federal employment tax purposes it never treated the individual as an employee for any period, nor did it ever treat workers holding substantially similar positions as employees during any period beginning after December 31, 1977;(2) all federal tax returns were filed on a basis consistent with the company's treatment of the individual as not being an employee; and (3) a reasonable basis existed for classifying the individual as an employee.
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