Classification of Employees and Employer Responsibilities

The classification of employees vs. independent subcontractors has been an ongoing battle between businesses and the Internal Revenue Service. If your business can classify your employees as independent subcontractors you avoid paying payroll taxes which usually costs the employer an additional 10% of the employee's gross pay.

Independent contractors are not subject to withholding or payroll taxes. They should be given IRS Form 1099 if they were paid more than $600 during a calendar year. If the IRS audits your business and determines you cave incorrectly classified employees as subcontractors you could be hit with a huge tax bill and penalties and interest.

Under common law rules, anyone who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

If you have an employer-employee relationship, it makes no difference how it is labeled. The substance of the relationship governs the worker's status. Nor does it matter whether the individual is employed full time or part time. You generally have to withhold and pay income, social security and Medicare taxes on wages that you pay to common-law employees.

The IRS will determine whether a worker is an employee if you prepare and file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. For more information on employees see IRS Publication 15-A.

One benefit of operating your business as a sole proprietorship is the ability to employ your children, under the age of 18 without paying social security and Medicare taxes.

If the IRS audits the business and determines you have incorrectly classified employees as subcontractors you could be hit with a huge tax bill and penalties and interest.

All employers must have an employer identification number, or EIN. If you do not have an EIN, you need to fill out IRS Form SS-4. The EIN is used on various federal employment tax returns.

When you hire an employee you need to do three things:

Give the new employee an IRS Form W-4 to fill out and return to your paymaster. This form is used by employers to calculate federal withholding taxes. The employee indicates, on the W-4, their marital status and the number of withholding allowances they are claiming. States with income tax may have their own form for the employee to claim withholding allowances. For example, Georgia uses a G-4 for this purpose.
Determine that you new employee has a valid work permit issued by the INS. You are required to complete INS Form I-9 for every new employee. Hiring illegal aliens could cost your business in INS fines. Legal aliens receive work authorization cards from the INS. In some cases you are required to see two forms of identification before hiring your new employee. The I-9 form tells the employer exactly what types of identification is required to prove the employee is authorized to work.
Some states require employers to withhold past due child support from their employees paycheck. Employers may be required to send a form, usually a W-4, to their department of revenue so the state can check their records to see if the new employee owes back child support.