She asked a very good question that many small business owners often have: How do you distinguish between independent contractors and employees who are on your payroll? Or more importantly, how does the IRS determine that?
There’s a 20-point common law test, internal revenue code section 5-30, that determines whether that person is an employee or an independent contractor. So even though you may be treating a person as an independent contractor, in the eyes of the IRS and the 20-point common law test, that may not be the case.
Ask yourself the following:
- Do you control the hours of the employees work?
- What risk of loss does the employee have? In other words do they bring their tools of the trade to your place, or do you provide them a place to work and all the tools, etc.?
- Do they have a DBA fictitious business name filed?
- Do they work with other people than yourself?
- Do they get a Form 1099 or W-2 from other sources?
See where I’m going with this? If you do work with other people, you have to be very careful what the IRS code says is the difference between and employee and an independent contractor. With an independent contractor you’re going to provide with a 1099 form and they’re going to pay their own taxes.
The interesting thing is that often people get caught on this by mistake. Everyone is going to have in his or her lifetime a disgruntled employee or worker who is going to go to the New York state unemployment compensation board and ask for compensation. And then person behind the counter is going to look up their records and say, “Wait a second, no one has ever filed wages on you.” And the person is going to say. “What is that about? I worked there 40 hours a week. I worked there 9 to 5 and they gave me an hour for lunch. I worked for them.”
The New York state unemployment compensation board is going to notify the New York City department of finance and the New York State Department of Revenue, and they’re the ones who are going to go in first to audit the business. And the IRS has agreements with 22 states, and New York is just one of them, where they share the information. So not only are you going to go through a state payroll tax audit you’re going to go through an IRS payroll tax audit, so by then you may as well kiss the business goodbye.
When it comes to payroll tax debt, the IRS has unyielding power and authority to collect. They have the power to padlock your front doors, putting you out of business, without obtaining a court order. So you need to be able to fight back with expert tax representation!
Listen to more tax advice for small business owners on Business Matters.
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