The ranks of part-timers and contract workers have swelled in recent years, partly as a result of a lengthy downturn in the economy. Although a growing contingency workforce may be the bane of labor advocates, using contingency workers has enabled more than one Mom-and- Pop to keep the doors open. It’s a simple formula: Pay a worker only when there is work to be done. Employing a part-time workforce keeps costs down, particularly during that crucial start-up phase.
Even so, there remains a proverbial fly in the ointment for small businesses that do not pay attention to the taxation laws affecting contingent workers. That’s particularly the case with IRS rules that specify when a worker is actually an employee and not an independent contracted service provider.
The IRS has a specific definition for categorizing a worker as a self-employed contractor versus defining a worker as an employee. Most small businesses steer clear of violating these rules, but start-up enterprises may incur penalties because they do not understand the agency’s definition of a contract worker. The key concept to keep in mind is this: Who has control over the worker? Is he or she self-directed or under the direct control of a supervisor?
Back in the time when payroll tax was levied in the single digits, withholding an amount sufficient to pay the tax bill did not pose the challenge it does today.
One audit of a business employing two dozen contract workers that were categorized incorrectly over a period of several years could result in a huge penalty. It’s one the government will be eager to collect in an era when tax revenues just don’t go as far as they used to in meeting the government’s need for cash. In fact, four dollars out of every 10 that keep government coffers flush with cash come from payroll tax, according to an April 2013 report from The New York Times. There’s plenty of motivation to collect every last dollar of payroll tax.
If you are thinking of bringing a new worker on board, first ensure you are in compliance with government requirements on taxation. Be sure you are familiar with the definition of a contract worker to ensure your business is staying in line with IRS payroll tax rules. If you’re still not sure, ask the IRS for a determination on whether or not your worker is a contractor or employee. Also remember there are special rules for a husband and wife business.