The Internal Revenue Code requires every employer to withhold Social Security taxes, Medicare taxes, and income taxes from the wages of its employees. These taxes, along with the additional contribution of Social Security tax made by the employer, comprise “employment taxes.” If your business has employees, whether part-time or full-time, the law requires your business to pay these employment taxes, and this tax obligation can serve as the Achilles’ heel of many businesses, especially small businesses. At the Ben-Cohen Law Firm, our Los Angeles tax specialists can draw on the knowledge not only of a CPA, but also an attorney, certified by the State Bar of California Board of Legal Specialization as a Taxation Law Specialist, to help you understand your employment tax obligations.
We can defend you against an employment tax audit by the Internal Revenue Service (IRS), or the California Employment Development Department (EDD). We can also analyze your payroll, and ensure that your protocols for collecting employment taxes are sufficient to prevent you from encountering a major problem in the future.How workers are classified: employee vs. independent contractor
Because the withholding requirement applies only to an employer’s employees, payroll tax problems typically arise when the IRS or EDD conclude that an employer has improperly treated employees as independent contractors. Both the IRS and the EDD use a complicated 20-factor test in evaluating whether a worker is an employee or an independent contractor.
Employers often prefer to classify workers as independent contractors because of the absence of employment tax withholding requirements. However, employers should tread carefully, because if your business categorizes a worker as an independent contractor, and declines to withhold taxes, the IRS may review that decision and, if the agency reclassifies the worker as an employee, it can impose potentially massive retroactive penalties.Methods of relief from a re-classified worker tax obligation
If the IRS reclassifies a worker as an employee, the employer may still avoid related tax assessments and penalties if it qualifies for relief under Section 530 of the Revenue Act of 1978. The taxpayer qualifies for Section 530 relief if it satisfies three tests: the “Reasonable Basis Test,” the “Position Test” and the “Tax Return Test.” An employer must have a “reasonable basis” for treating the worker as an independent contractor, must have treated workers in substantially similar positions consistently with how it treated the worker at issue, and must have filed its tax returns in a manner consistent with its classification of the worker as an independent contractor. Because Congress intended to protect taxpayers who made good-faith errors in classifying workers as independent contractors, courts will broadly construe the “reasonable basis” requirement in favor of taxpayers.
An additional avenue for relief exists through Section 3509. This relief offers an opportunity for a reduction in employment tax assessments if the employer issued a Form 1099 for the worker. The reduced rates are 1.5 percent of wages as withholding and 20 percent of the employee’s share of Social Security to be paid by the employer. To obtain this relief, an employer must satisfy certain reporting requirements with respect to the reclassified employee, or show that it had reasonable cause for its failure to file the proper returns.
Misclassifying a worker as an independent contractor instead of an employee can trigger substantial, and harmful, financial consequences to your business, but it need not be so. The tax law contains a variety of options for reducing, or eliminating, the cost of a misclassification. Our firm has the knowledge and the resources to assist you with properly classifying your workers and dealing with the IRS or EDD if you have received a demand for back-owed employment taxes on a re-classified worker. For your questions about employment taxes, contact the Los Angeles tax attorneys at the Ben-Cohen Law Firm.