The Tax Attic with Jerry Coon

Jerry Coon, Enrolled Agent

Jerry Coon, Enrolled Agent

What exactly can be done if you receive a 1099-MISC as a subcontractor when you think you should receive a W-2 as an employee? Receiving a 1099-MISC is not always a negative, but as my discussion of last week pointed out, we just have to say the tax implications are immense. But, regardless of the tax consequences, does the Internal Revenue Service have a procedure to follow if you are convinced that you should have received a W-2? The answer is yes. It is a common problem, because it is almost always advantageous to a payer to report payments made to someone as a subcontractor instead of an employee.

Why is it more advantageous to call a recipient a subcontractor and not an employee? First, payments to an employee are subject to a matching Social Security and Medicare tax of 7.65%. Payments to a subcontractor are not subject to this 7.65%, so the payer instantly adds 7.65% to his bottom line.

Second, payments to an employee are subject to federal and state unemployment tax. The federal unemployment tax rate is normally 0.8% of the first $7,000 of wages, or $56 per person. Since Michigan owes the federal government billions of dollars, there is a 0.3% surcharge, or $21, added for the year of 2009. Michigan unemployment rates are variable, but a new business will pay 2.7% of the first $9,000, or $256. The maximum rate is 11%, so $256 could be very low. Payments to subcontractors are not subject to these two taxes. This adds a few more hundred dollars to the bottom line.

Third, payments to subcontractors are not subject to workman’s compensation insurance. For construction employers, that rate of insurance could be as high as $30 per thousand of payroll.

Fourth, employees are quite often covered by those items called fringe benefits. They might be covered by health insurance, receive paid vacation and personal time off, receive time-and-a-half pay for hours worked over 40, be paid a premium amount for working on weekends and holidays, receive an automobile as part of their compensation package, and be paid for continuing training, etc., etc. A subcontractor receives none of these benefits.

Fifth, the employer might have some type of retirement plan set up. An employee participates in this plan. A subcontractor does not.

Add all of these differences up and it can be a whole lot cheaper to give a person a 1099-MISC and say he is a subcontractor even if he is really an employee. It happens often enough that the IRS has developed a form to submit when a person receives a 1099-MISC when he thinks he should receive a W-2.

The form, an SS-8, is entitled “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” It can be obtained at the forms link on the IRS’ website at www.irs.gov. It is a three-page form that goes through several factors to determine employee-versus-subcontractor status. The factors are grouped into four major headings, Behavioral Control, Financial Control, Relationship of Worker and Firm, and For Service Providers

or Salespersons.

As the form is completed, it will indicate how much control the company has over the taxpayer. The more control a company has over the person, the more it will look like the taxpayer is an employee. Less control will look more like a subcontractor. The SS-8, by answering a variety of questions, will indicate that a person is an employee or a subcontractor.

If the IRS receives an SS-8 from an individual taxpayer, it will be processed as one side of the story. The identified company will be sent an SS-8 and the company will get to tell the other side of the story. As we all know, there are usually two sides to most stories. In these cases, the IRS is the judge. If they find that the taxpayer is indeed an employee, there are a whole lot of employment forms that have to be amended and a whole lot of payroll taxes that have to be paid.

Of course, the IRS is not always the final judge. The company can appeal to a tax court judge and, from time to time, there are some very large court cases that come down the pike. As you might imagine, if there are 500 people involved, the payroll tax implications could run into the millions of dollars.

By the way, the IRS estimates that it takes 23 hours, 58 minutes to complete the three-page SS-8. It’s not an easy form to fill out and, of such things, court cases are made. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns
Action Tax Service on Northland Drive in Rockford.
Contact Jerry at his website at www.actiontaxservice.com.

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