There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Welcome back for part two on worker classification. So a quick recap in part one. If you haven't listened to that, definitely go back and listen. Uh, first part of worker classification rules. In that part, I covered the three part test [00:00:30] for whether a worker should be classified as an independent contractor or an employee. And that test has to do with the common law control standard. In other words, we're looking at whether the employer has the right and the ability to control how that worker is performing, the tasks that are assigned, the control over how the work is done, or just control over what the output is. And those three [00:01:00] categories of evidence were behavioral control, financial control and business relationship. Part one is a is a discussion and breakdown of those three categories of evidence and how we got to that point. But in part two, we're going to look at some other types of specific worker arrangements that are defined actually in the Internal Revenue Code, and how those specific [00:01:30] types of arrangements should be treated for federal tax, especially employment tax purposes. And we're also going to look at what happens and what are some relief options for both employers and workers when a worker is not correctly classified. So let's start with some of these statutory approaches to specific kinds of workers. Now in the first part I mentioned two of [00:02:00] the kinds of statutorily defined employees. The first one is corporate officers.
Jeremy Wells: Corporate officers are always employees by definition. That's very important for those of you either working with S corporations or those who own and operate S corporations, because if you have decision making authority within that corporation, whether it's a C corporation or an S corporation, you are a corporate officer and by definition, you are an employee of that corporation. [00:02:30] And your compensation should be reported as if you're an employee. It's very important to keep in mind. The second type is a common law employee. And again, that's what we just discussed in part one and what I just briefly reviewed. So if a worker meets that common law control, uh, test of, uh, whether the employer has the right and ability to control the way that worker performs their duties, then [00:03:00] that person is a common law employee of the employer. The third category here that we need to look at is what are considered and what are often called statutory employees. And these particular kinds of professions are interesting because by statute they are treated almost as a sort of hybrid category in some ways. They are [00:03:30] treated as employees, and in other ways they have some of the benefits of being treated as independent contractors. So the IRC lists workers in for specific occupational groups who, under certain circumstances, are considered employees for purposes of FICA tax that Social Security and Medicare. And then in some instances for fuda or federal unemployment tax, but not for federal [00:04:00] income tax withholding.
Jeremy Wells: And this is really key. So these individuals are employees essentially for employment tax purposes, but they are not for income tax purposes. So they may have the Social Security and Medicare tax withheld. Their employers may be responsible for unemployment tax. However, the employer is not responsible for withholding income tax. And that's actually going to that responsibility is going to fall squarely [00:04:30] on the worker in order to account for federal income tax. So those for occupational groups are agent drivers or commission drivers. And those will have both FICA and Futa withheld and paid by the employer. Full time life insurance salespersons will only have Fico withheld, not unemployment tax. Then [00:05:00] traveling or city salespersons will have both FICA and Futa paid by the employer, and then home workers will have FICA only withheld. Individuals working in these occupations who are not corporate officers or common law employees are so-called statutory employees, and these come from IRC. Section 3120 1D3. Now, by agent drivers or commission drivers, [00:05:30] we mean workers who distribute certain kinds of goods with in usually within a defined area. So that's going to be meat or meat products, vegetables or vegetable products, fruit or fruit products, bakery products, beverages other than milk or laundry or dry cleaning services. Now, that is a fairly specific list of goods or services that [00:06:00] that driver is delivering for. But if you have a worker who is engaged in delivering any of those kinds of goods, then that individual needs to be treated as a statutory employee.
Jeremy Wells: That means the employer is withholding both FICA and paying Futa, but then not withholding income tax and the worker's W-2. All statutory employees are employees, so they do get w-2s. But that W-2 is going to indicate by [00:06:30] checking the box in box 13 that that individual is a statutory employee. Now, I also mentioned homeworkers. Homeworkers here traditionally included, but wasn't limited to workers who would make things like clothing, bedding, needlecraft products or other similar sort of textile products at home. But now today, it also can include workers who provide typing or transcribing services. So [00:07:00] when we say home workers, we don't mean any worker who's working from home. But there are certain types of professions that typically work from home that are considered home workers for the purposes of being defined as statutory employees. So if you have a client or you are working in a field that has to do with typing or transcribing, you're probably a statutory employee. Wages paid to agent drivers or commission [00:07:30] drivers and traveling or city salespersons are subject to both FICA and Futa withholding, but not federal income tax withholding and then wages paid to full time life insurance. Salespersons and home workers are only subject to FICA withholding. It's important to keep those in mind. If you if you employ those workers or if you're working for employers of those professions.
Jeremy Wells: Now, [00:08:00] statutory employee rules apply. When a worker performs services for a business for compensation and meets the following requirements. First, the contract of service contemplates that the worker will personally perform substantially all the work. In other words, there's not going to be any delegation from that worker to anyone else. If the contract is written in such [00:08:30] a way that the individual worker has either the ability or the right to delegate that work out to others, then that individual is not a statutory employee. That individual is actually an independent contractor. So if the contract's written in such a way that that individual will be the the one, the sole individual that is providing those services to that employer, then that individual may qualify as a statutory employee. Second, the worker has no substantial investment in [00:09:00] facilities other than transportation facilities used in performing the work. In other words, notice that a lot of those statutory employee categories are based on delivery or driving around. So we're talking about salespeople. We're talking about drivers, delivery truck drivers. They are in general going to need transportation. That's going to be a critical component of their work. And so in those cases they can own their own car. They can own their own delivery [00:09:30] truck. But that has to be really the only substantial investment into the business. If they're investing into any other kind of property, plant equipment in that business, then that individual probably will not qualify as a statutory employee.
Jeremy Wells: And then third, there is a continuing work relationship with the business for which the services are performed. This is not a one off or occasional kind of arrangement. This is regular, steady work. Again, that goes back [00:10:00] to the nature of employment. Employment doesn't have to be constant, consistent work, but it is regular recurring, uh, work that is part of a ongoing relationship between the employer and the worker. If that doesn't exist, then it's likely more of an independent contractor setup that is from Treasury Regulation section 31.31 21 D1D42. Now that's pretty deep into that regulation, but [00:10:30] it's important to keep in mind that if you have a worker that meets or is in one of those four categories, or you have a client that is regularly working with individuals in one of those four categories, it's probably important to understand the statutory employee requirements and make sure that those are correctly applied and so that those workers are correctly categorized. Here's where the benefit [00:11:00] potential benefit to a worker who is classified as statutory employee can come in. A statutory employee includes payments reported on form W-2 with box 15. Excuse me. I think earlier I said box 13, it's actually box 15 where that statutory employee box is checked on schedule C. Now this is what is is different and can be a bit confusing. The first time you see one of these w-2s that W-2 is not reported as wages [00:11:30] on page one of the form 1040 like a normal W-2.
Jeremy Wells: Instead, those payments are reported on schedule C, line one as gross income, and then the statutory employee can Deduct related expenses on schedule C. So this these payments are reported on a W-2 as if the individual is an employee. There is going to be FICA and Futa withholding [00:12:00] and those payments are reported on schedule C. It's a bit of a weird treatment of that. If you are a tax professional, tax software usually has a fairly quick way to report this. Uh, and so again, it's important to check for whether that box 15, uh, statutory employee is checked. If so, then you will get the benefit. That individual will get the benefit of both, uh, having an [00:12:30] employment situation with their employer, but then also be able to deduct those expenses on schedule C note that that is not available for regular employees or non-statutory employees ever since Tax Cuts and Jobs Act of 2017 was passed, we have not, for federal tax purposes at least had employee business expenses deductible on form 1040. Note that services provided as a [00:13:00] statutory employee do not constitute the carrying on of a trade or business for purposes of the Self-Employment Contributions Act. So in other words, they are not subject to self-employment tax. Statutory employees are required to file a schedule C for services performed as a statutory employee, separate from a schedule C that reports net earnings from self-employment.
Jeremy Wells: So do not include the net [00:13:30] income from the statutory employee. Activity in earnings from self-employment. For purposes of calculating self-employment tax or any other part of the return that is going to draw on net earnings from self-employment, such as, for example, contributions to a retirement plan that is available to a self-employed person such as a Sep IRA or self-employed pension, IRA or a solo 401 (K) or any other kind of retirement account like [00:14:00] that. Except for full time life insurance salespersons statutory employees remain independent contractors for employee benefit purposes. In other words, statutory employees are not eligible for employee benefits that would be offered to non-statutory employees by the same employer. There is the one exception here for full time life insurance salespersons. [00:14:30] They are treated as employees not only for FICA tax purposes, but also for certain employee benefit programs maintained by the business. However, they can't base contributions to a self-employed retirement plan on the compensation received from the insurance business. This is one of those cases where tax law just kind of won't make sense. [00:15:00] But, uh, think of it this way. You have the four different categories of statutory employees. Insurance salespersons are the one category that are eligible for certain employee benefit programs. Otherwise other statutory employees are not. However, because those insurance salespersons are eligible for some of those employee benefits, they cannot base contributions [00:15:30] to self-employed retirement plans on the compensation received from the insurance business.
Jeremy Wells: And there is one category here that is, uh, described, uh, in IRC section 3506 as a statutory non employee. There are actually a couple other groups. This is the first one. So a person who only connects sitters for either children, elderly or the disabled with [00:16:00] employers is not treated as the sitter's employer. If they are compensated on a fee basis and do not handle wages. This is something that's fairly common. Is these essentially, uh, finders that will help connect, uh, sitters. So babysitters or individuals who will, uh, sit and stay with the elderly or the disabled and these services will connect those sitters with the [00:16:30] households and the families that need them. If that is all those services do, if all they do is make those connections and they collect a fee for making those connections. Then by statute, they are not the employer of the sitters, and they are also not the employee of their client. Instead, they act as an independent contractor with [00:17:00] with respect to both sitters are not employees of the placement services unless the placement service collects the fees and pays the sitters. In other words, they. They tend to operate as a third party, and that just merely connects the two. Now the sitter can be a worker and therefore an employee or independent contractor of the client. The the household or the taxpayer that needs the sitter. [00:17:30] But that connecting service is just a third party to that arrangement.
Jeremy Wells: As long as the third party, the connector, is not the one that's actually paying wages out to the sitter. And then there's another category of statutory non-employees, two more categories. The first one is real estate agents, and the second is direct sellers. A [00:18:00] qualified real estate agent and a direct seller is are by definition, not employees by statute. So qualified real estate agent is any licensed salesperson whose pay is based on sales or output, not hours worked and who has a written contract stating they are not an employee for federal tax purposes. This is a typical. [00:18:30] In fact, this is almost a universal arrangement between real estate brokerages and the actual salespeople, the real estate agents. There's a contract between the brokerage and the agent that says that the agent is not an employee of the brokerage, and real estate agents tend to get paid at a commission, which is usually a percentage of the transactions that they facilitate. In those cases, by statute, [00:19:00] that individual is not an employee and and is an independent contractor. A direct seller is a person who sells or solicits consumer products for resale or outside a permanent retail establishment, or distributes newspapers, provided that their pay is based on sales or output, and that they have a written contract stating they are not an employee for federal tax purposes. So it's a similar setup as real estate agents only [00:19:30] for consumer products for resale.
Jeremy Wells: And this comes from IRC section 3508. So we get the, uh, the statutory non-employees from IRC section 3506 for those sitters and IRC section 3508 for real estate agents and direct sellers. Those are the three categories of statutory non-employees. And then you combine that with statutory employees, [00:20:00] common law employees, and then corporate officers. And those are really the four main categories of workers that are described in the Internal Revenue Code. Essentially, if you have a worker who does not meet one of those three criteria, either a corporate officer, a statutory employee or a common law employee, then that individual [00:20:30] is likely an independent contractor. However, we're going to have to look at anytime we have a relationship between employer and a worker, we're going to have to look at that common law control test to determine whether the employer has the right and or the ability to control the way that worker is working. And if so, we're probably going to lean toward classifying that worker as an employee. Otherwise, if [00:21:00] the employer is not, uh, exercising that control and the way the agreement between the employer and the worker reads really doesn't give the employer the right to control the way that worker does their work. In that case, we're pretty safe sticking with an independent contractor arrangement. Now, there are situations where you could have a worker, uh, operating as both [00:21:30] an employee and an independent contractor, so a worker can perform services for a single business in two or more capacities.
Jeremy Wells: It's possible that in one capacity, the worker should be classified as an employee, but in another as an independent contractor. So, for example, a corporate director in that capacity is not considered an employee of the corporation for those services, even if that worker also serves [00:22:00] as an employee or officer of the corporation for other services. You can imagine a corporate officer who also sits on the board of directors. In fact, this is fairly common for a lot of companies, especially smaller family held companies. That individual may serve in both roles as both a corporate officer as well as a corporate director. If their service in the way of being a director rises to the level of deserving compensation [00:22:30] for that work. In other words, there are regular board meetings that individual spending a significant amount of time doing. Uh, director work. Then that individual might be compensated as a non-employee, as an independent contractor, as a director, but then also be compensated as an employee, as a corporate officer. And that actually comes from revenue ruling. 58 505 uh, which really discusses this, uh, [00:23:00] potential for a dual status of a worker for these split duties, what this, uh, revenue ruling actually focused on was a situation where certain individuals worked as both corporate officers and as, uh, independent sales agents, insurance sales agents in an insurance company.
Jeremy Wells: So they worked independently selling policies, but they also provided the administrative services that, uh, [00:23:30] it took to actually run the company. So the IRS and this revenue ruling determined that they were both employees. Uh, for federal employment tax purposes with respect to duties performed as officers of the company, but then they were not employees. Uh, for purposes with respect to their insurance sales activities. So again, it's entirely possible that an employee, uh, a worker is providing services to the same employer where one [00:24:00] set of services would lead to classification as an employee, another set of services would lead to classification as a non-employee, as an independent contractor. And it is possible to do both. I have seen questions asked of other, uh, by other tax professionals where they have a tax payer that received both a W2 and a 1099 neck for non employee compensation from the same entity. Sometimes that might be an error, sometimes that might be a reporting [00:24:30] error. Sometimes that could reflect that. That individual worked for a brief time as an independent contractor. And then because the employer was satisfied with the work or just the nature of the relationship changed, that individual was brought on as an employee. And so some of that compensation truly was paid to an independent contractor. And at some point, that relationship was changed by the two parties to where now that individual is an employee. And then there are situations like this dual [00:25:00] status, where at the same time, that individual is earning compensation both as an employee and as an independent contractor.
Jeremy Wells: Those questions that I see will, will often, you know, end with something like, you know, can this be correct? Can it be correct that a single individual is getting both a 1099 neck and a W2 from the same entity, from the same employer? And in that case, I would ask for more information. I would ask, well, what is the nature of the payments that produced [00:25:30] the 1099 NAC versus the W2? Why did the employer report two different sets of compensation for the same worker? It's, it's entirely possible, uh, that, that that worker, uh, got compensation of two different kinds with respect to employment tax. Now it's also possible that that was erroneous, uh, and [00:26:00] should have been fixed. I've seen cases where the, uh, worker did not have the necessary paperwork, uh, to the employer in time to be on payroll, uh, when that worker had already been working for the employer. I've also seen misclassifications where the employer just didn't know that they actually needed to treat that worker as an employee. And after a little bit of time, either the [00:26:30] bookkeeper or the tax advisor or someone raised the point that, hey, I noticed you're making payments to this individual. What is this individual doing? What is this individual, uh, providing for your business? Oh, that sounds more like employment than an independent contractor setup.
Jeremy Wells: And if you can't tell, I'm. I've been in the position where I'm the one having to have this conversation, uh, with a client. So it's possible that [00:27:00] you have a situation where some payments were made to a worker, where that worker should have been classified as an employee. However, for whatever reason, wasn't until later in the year when that worker was then compensated as an employee. In other words, their payments were run through payroll. In those cases, ideally, you would have all of those payments if there was no change in the actual relationship between the worker and the employer. Ideally, you would have [00:27:30] all of the payments reported through payroll. However, sometimes you get a worker that just isn't added to payroll until later until after some of those payments have made. And maybe in those cases, you get both payments that are reported as wages and payments that are reported as, uh, non-employee compensation. It's, it's unfortunate that, you know, that happens sometimes, but it's, it's inevitable. Uh, and so in those cases, we just have to go to the [00:28:00] taxpayer, go to the client, and then ask for a little bit of clarification of what actually happened and if there's something that needs to be fixed. If we have a situation where a worker truly was misclassified, then we would need to discuss, uh, what the employer, uh, or maybe the worker, uh, need to do in those situations.
Jeremy Wells: And that brings us to the next section of this episode, which is looking at relief for misclassified workers. Now, there are certain kinds of relief that are available for [00:28:30] both employers and employees. But first of all, let's look at what the actual rules here are as far as the responsibility to correctly classify a worker, whose job is it to make sure that a worker is correctly classified? Well, it's actually the employer's, and there's nothing in the code that specifically says that an employer is responsible for correctly classifying [00:29:00] that worker. However, we get there indirectly by way of looking at the sections of the Internal Revenue Code that deal with employment taxes. So an employer must withhold and pay employee federal income tax withholding, employee FICA withholding and employer FICA. Those come from IRC sections 3402 3101 and 3111, respectively. So 3402 is employee income tax withholding. 3101 [00:29:30] is FICA withholding. And then 3111 is the employer FICA. Now employer must hold the amounts withheld from employee pay in a special fund in trust for the United States. Subject to significant penalties if unpaid. That's IRC section 7501. So what we get from combining these sections together is that the employer is responsible for correctly identifying [00:30:00] payments to a worker as wages, and therefore correctly withholding and paying employment taxes based on those wages. And if that isn't done, if the employer does not withhold and pay those employment taxes, then the employer is the one who is responsible and penalized.
Jeremy Wells: Now, in section 3402 D of the IRC, we get that in. If [00:30:30] an employer fails to withhold employment taxes from an employee's pay, then it will not have to pay uh, that specific amount of UN withheld tax. Provided the employee eventually pays the tax. So what does this mean? Because remember section 3402 refers back to federal income tax withholding. In other words, if an employer failed to [00:31:00] withhold federal income tax from one of its employees wages, and that employee subsequently wound up paying the income tax due, then the employer is off the hook, essentially. Um, now, this doesn't always apply, and I'll talk about some cases here in a minute where this doesn't apply. But if the employer fails to withhold income tax and the employee subsequently winds up paying the tax [00:31:30] anyway, then the employer is essentially off the hook. If the employee never pays the tax, though, then 3402 D doesn't really apply because the tax hasn't been paid yet. And in that case, we might have a situation where the employer is actually still on the hook. If an employer misclassifies a worker, then there are some options here for statutory relief. So an employer is generally liable [00:32:00] for the Social Security, Medicare and the withheld income tax if it incorrectly treats an employee as a non-employee. However, IRC section 3509 applies if the employer treated a worker as a non-employee and did not Intentionally disregard its responsibility to withhold employment taxes from employee pay.
Jeremy Wells: Section 3509 gives some relief to employers, but only [00:32:30] in the case where they did not intentionally disregard the responsibility to withhold employment taxes. In other words, if it was an honest mistake, if the employer misclassified the worker but did not truly intend to disregard its responsibility to correctly classify workers as employees and therefore withhold and pay employment taxes for that employee, then section 3509 [00:33:00] applies in the case where this is true, where the employer did not intentionally misclassify and fail to withhold employment taxes. Then the employer has to pay the following 1.5% of wages paid as federal income tax withholding and 20% of wages paid as employee withholding, 20% of the amount that should have been [00:33:30] withheld from employee wages. These are significantly reduced amounts from what the employer would have had to withhold and therefore pay in. Now, this assumes that the employer correctly reported those payments to that worker on form 1099. Assuming that the employer [00:34:00] also did not intentionally disregard its responsibility to correctly classify that worker. So let's assume for the moment that the employer just didn't know better and thought that worker truly was an independent contractor. Then the employer still has a form 1099 filing requirement for the payments that it made to that worker. If that employer fails to file form 1099, then those payments double. It becomes 3% [00:34:30] of wages paid and 40 for federal income tax withholding, and then 40% of its responsibility for FICA withholding.
Jeremy Wells: That all comes from IRC section 3509, a 35 09A is, uh, really the whole section 3509 is important to understand. If you're working with an employer that is on the verge of realizing that it has misclassified some workers, uh, [00:35:00] that determination of the liability under section 3509 has no effect on paid taxes, though. So if section 3509 applies, then the following is true. First, the employee remains responsible for any tax assessed or collected. This is only relief for the employer. We're not looking at the employee here. Under section 3509, the employer can't [00:35:30] recover any UN withheld tax from the employee and sections 34 02D, which I just read before, that any tax paid by the employee, the employer is no longer responsible for, at least in terms of federal income tax withholding. Um, those do not apply. And then also section 6521 does not apply. So section 6521 overrides the statute [00:36:00] of limitations. If a refund of either self-employment or payroll tax is barred, but could be credited toward liability of the other in case of an erroneous Payment. In other words, you have a worker that you have misclassified as an independent contractor. That independent contractor has correctly reported from their perspective the income as self-employment income and paid self-employment tax [00:36:30] on those net earnings from self-employment. What 6521 does is allow for the payments of self-employment tax to be credited toward a liability of payroll tax, even if the statute of limitations has passed.
Jeremy Wells: Uh, for a refund of that self-employment tax, that's the only time it's triggered, though, if the statute [00:37:00] of limitations hasn't been passed yet. Uh, then we don't need 6521 that refund and then application could just happen anyway. But if we're outside of the statute of limitations. Then we need some mechanism to apply the erroneous either self-employment or payroll tax payment toward the correct, uh, one that does not apply in a case where we have [00:37:30] a determination of an employer liability under section 35. Oh nine there's a tax court case. Uh, Mescalero Apache Tribe v Commissioner. 148 Tax court 11 from 2017, where the tax court held that the disclosure of third party, uh, taxpayer return information to absolve an employer of a section 3402, a tax liability was not barred. Therefore, [00:38:00] an employer can access IRS records to determine if its workers paid taxes on income reported via form 1099. So that's what we're getting at here. Under section 3509 is we're essentially trying to make the IRS whole. We are looking at what the liability would have been had the employer correctly classified workers as employees, and therefore withheld [00:38:30] and paid employment taxes. We're looking at what actually happened with misclassified workers as independent contractors and what they paid in as self-employment tax and their own income tax. And we're essentially looking at the difference. And if the employer is trying to make a case for the fact that the that its workers as independent contractors actually paid the taxes that [00:39:00] they should have, then that's essentially a way for the employer to get itself off the hook.
Jeremy Wells: But the only way it would know that is if it had access to the IRS records, or if it's workers just freely admitted that they paid taxes. But really, the best way for the employer to confirm that is looking at IRS records. However, there are privacy concerns, and the IRS is not able to disclose taxpayer information to a third [00:39:30] party, even if that third party is an employer in this case. But the tax court are determined that this essentially puts employers at a disadvantage. And so the IRS is required now, under this tax court decision to disclose that necessary information to employers in these kinds of determination cases. Back to section 3509. Relief. Again, intentional disregard to [00:40:00] correctly classify a worker and therefore withhold and pay employment taxes nixes any kind of statutory relief. Reduced rates under section 3509 don't apply if the employer intentionally disregarded withholding. If the employer withheld federal income tax but not FICA taxes, or if the worker is a statutory employee. So this is another reason why it's important [00:40:30] to correctly classify those employees if they are statutory employees. Section 3509 doesn't count if the employer withheld income tax but not FICA tax, 3509 doesn't count. And then if the employer intentionally disregarded withholding entirely, section 3509 doesn't count.
Jeremy Wells: So note that intentional disregard is different from, but might be related to willful failure to collect, account for, and pay payroll [00:41:00] tax, which would result in a trust fund penalty under section 6672. It's a separate but related determination of that trust fund penalty. Whether that employer intentionally disregarded its requirement to withhold and pay taxes and therefore qualify for relief under section 3509. There's also section 530 relief. [00:41:30] Now, this is not section 530 of the Internal Revenue Code. This is actually section 530 of the Revenue Act of 1978. This provides relief that terminates a taxpayer's employment tax liability with respect to an individual not treated as an employee. So an individual whose payments were reported as an independent contractor. If the following statutory requirements are met, a reporting consistency, a substantive consistency [00:42:00] and reasonable basis, the reporting consistency means that the taxpayer must have timely filed the requisite information returns consistent with the treatment of the worker as a non-employee. In other words, it had to file the 1099 substantive. Consistency means that the taxpayer or predecessor treated the worker or any worker holding a substantially similar position as an employee. [00:42:30] This is a facts and circumstances determination, but we've got to look at the employer and see if there are any similar roles within that organization. And if we see a an inconsistent treatment of workers with similar jobs and job descriptions and duty assignments, if one is being treated as an independent contractor and the other one is treated, being treated as an employee, [00:43:00] then that's going to disqualify that employer from section 530 relief.
Jeremy Wells: And that's going to depend on a review of actual day to day services performed and a comparison of the job functions, not just looking at the similarity of job titles or categories. And then finally, reasonable basis. The taxpayer has to have reasonably has to have reasonably relied on either a prior audit determination, some judicial precedent or standard industry practice [00:43:30] when, uh, that, uh, employer classified that worker incorrectly for reporting consistency. In other words, the taxpayer must have filed 1099. That's only true if the nature of the work and the employer means that, uh, the, uh, that a 1099 was appropriate. So, for example, if we're looking at a worker who, uh, [00:44:00] thought that the worker truly was a volunteer, for example, then no information returns would have been required. So there are some exceptions, but they're limited. And in general, if you have a worker that is providing work to the point of, uh, getting some form of compensation and therefore being incorrectly classified, then it's going to be a tough case, uh, to say that that worker should not have gotten a 1099 reporting. So [00:44:30] in other words, we're looking for word 1099 filed. Is that consistently applied across similar workers, uh, in that organization? And then does that employer have a reasonable basis for making that worker classification? And then on the worker side, there is, there are some ways that the worker can, uh, try to get some relief because keep in mind, if a worker is misclassified, then that worker is now on [00:45:00] the hook for not only income tax but also self-employment tax as well on those net earnings from self-employment.
Jeremy Wells: So that worker might be able to deduct some, uh, ordinary and necessary expenses in the way of, uh, earning that self-employment income. But that doesn't necessarily mean that worker is better off than they would have been with an employer paying half of the FICA, uh, along [00:45:30] with withholding federal income tax. So you can imagine some situations where, uh, this worker might have not had significant, uh, deductible expenses and therefore the cost of not only, uh, both halves of self-employment tax, both the employer and the employee, half of employment tax, uh, but then also, uh, the income tax and any late payment penalties and underpayment penalties that might [00:46:00] be assessed on a balance due. Resulting from that self-employment income. That worker might be at a disadvantage by going along with being classified as an independent contractor in those cases. A misclassified worker can file form 8919 uncollected Social Security and Medicare tax on wages. Now, this will help with FICA tax. It won't do anything about income tax, but the worker can use form 8919 to calculate and [00:46:30] report his or her share of uncollected Social Security and Medicare taxes due on his or her wages.
Jeremy Wells: Now, by using form 8919, the employee Social Security and Medicare taxes will be credited to the employee's Social Security records. So that can help the employee. But it might also trigger an issue with the employer. So the [00:47:00] worker has to be careful. Essentially about using this form, which might result in a decision not to file it in the first place. And I've actually been involved in situations where I thought my client really should have been treated as an employee instead of an independent contractor. I told them about that, and they were perfectly fine going along with the status quo. Uh, in those cases, I didn't, I didn't push, I didn't insist. I just [00:47:30] did what I thought was my due diligence and my ethical responsibility at the time of informing my client that I think there is a worker classification issue here. If you agree, then here is what I recommend doing to address it. However, it's ultimately the taxpayers decision whether to address whether to agree that there is a classification issue and what to do about it. For form [00:48:00] 8919, the taxpayer is going to select, uh, one of four reason codes A is that, uh, I the taxpayer filed a form SS eight and received a determination letter stating that I am an employee of this firm. So form SS eight. Uh, I'll talk about here in a minute.
Jeremy Wells: Uh, code C is that I received other correspondence from the IRS that I am an employee. Code G is that I filed form [00:48:30] SS eight with the IRS and haven't received a reply yet. And then code H is that I received a form W-2 and a form 1099, miscellaneous or NSC from this firm for 2025, and the amount on form 1099, miscellaneous or NSC should have been included as wages on form W-2. In this case, the instructions for form 8919. Say not to file form SS [00:49:00] eight. If you select that code H, because the employer providing both AW2 and a 1099 indicates that that worker probably should have been a W2 employee all along. Although as discussed earlier, that may not exactly be the case. Now, if none of the reason codes apply, then the taxpayer should use reason code G, uh, and file the form SS eight as soon as possible by the date the tax return [00:49:30] is filed. Now form SS eight is essentially, uh, going back through those three categories of evidence from the common law control standard and applying them to the taxpayers specific facts and circumstances. So form SS eight determination of worker status for purposes of federal employment taxes and income tax withholding Applies those three categories of evidence, and essentially is a questionnaire [00:50:00] that either the firm or the worker can fill out and file with IRS. The firm might use this as a way of trying to show that the worker was actually correctly classified as a contractor, and the worker might use SSH to try to get the IRS to convince the employer that the worker should be classified as an employee.
Jeremy Wells: When either side files form SSH, [00:50:30] then the IRS might disclose the information provided to the firm to the worker, or if there is a third party that is handling the payment of the the payments to the worker, then IRS can disclose and involve that payer as well. In order to assist in the determination process. Now, the first step of that process is for the IRS to acknowledge receipt of form SS eight. So this will look [00:51:00] like a letter coming back to the taxpayer who filed it. The second step is the IRS attempts to get information from all the parties involved by sending those parties blank forms. Ss eight for completion. This will essentially give the other side in this a chance to answer and describe the nature of the working relationship from their perspective. So if the worker files form SS eight and IRS acknowledges receipt [00:51:30] of that, then IRS will send a blank form SS eight to the firm, to the employer, and let the employer, uh, fill that out and respond. And at that point, a technician is going to review the facts and the forms SS eight apply the law and then render a decision. Now that that decision can either be a binding determination that is in the form of a letter to [00:52:00] the parties, or it can be a non-binding advisory information letter.
Jeremy Wells: And that's just going to depend on the technician and what the technician is able to determine based on the facts and circumstances and the evidence presented by both sides. Now, that determination does not constitute an examination of any federal tax return. This is all done separately. This is not done along with filing a [00:52:30] tax return. So from the IRS perspective, this is a completely separate matter from any federal tax return. So taxpayers do not have the same appeal rights for this determination as they would, for example, with an examination of a federal income tax return. However, a taxpayer can submit additional Information, maybe something that they remembered or something that wasn't brought up initially with the SS eight and request a reconsideration of the determination. [00:53:00] But at that point, it's going to be up to the technician in the IRS whether to reconsider and if so, if there's any change in the determination. Okay, that's that's a lot for this episode, but essentially it comes down to a few key takeaways here. So certain workers are classified by statute as employees. I mentioned corporate officers at the end of part one. Uh, and then in this episode, we've got, uh, those statutory employees, [00:53:30] those four categories of statutory employees. And then we've also got some statutory non-employees that we need to keep in mind.
Jeremy Wells: But for those statutory employees, they actually retain some characteristics of independent contractors. And those statutory employees have unique reporting requirements that include both Fico withholding and schedule C reporting. Employers, though, are ultimately the ones responsible for correctly [00:54:00] classifying workers, and it's the employers that will face penalties for not correctly classifying workers and therefore not reporting and withholding employment taxes. If an employer is confused or not sure of how to classify a worker, then it should at minimum, file forms 1099 to report the payments made to that worker. And really, the safest way to approach this is to use form [00:54:30] SS eight to request a determination by the IRS. If all of that either doesn't happen or if it does happen. But now the worker has been classified as A or should has been determined to be an employee, then there are some avenues for relief for employers, and both employers and workers can request that determination of status from IRS. So in cases where it's just not clear, it [00:55:00] might be best for the employer and the worker to agree to request that determination from IRS. So if you found value in this episode, please let me know by liking leaving a comment in your podcast application of choice or on YouTube, wherever you're watching or listening to this. And then, uh, for the next episode, we are going to dig into, uh, what has been over the last several years, one of the most interesting, uh, [00:55:30] and a relatively complex addition to tax law. And that is the qualified business income deduction. Thanks.