Title Match

How firms label their workers has important tax ramifications.

How Does your waste company classify its workers? Is everyone who gets a paycheck considered an “employee?” Are some members of the workforce “independent contractors?” The difference translates into paperwork, dollars and potential liability.

The Internal Revenue Service (IRS) is not the only agency concerned about payroll taxes. In a time of dwindling revenues, state labor and employment departments also are putting employee classification decisions under the microscope.

A key issue is whether a particular job is being performed by an employee or an independent contractor. The choice has significant state and federal tax implications for the company and the worker.

Employers should know that IRS and nearly two-thirds of state labor agencies routinely share information. The goal is to “reduce fraudulent filings, uncover employment tax avoidance and ensure proper worker classification,” according to an IRS spokesperson.

The Questionable Employment Tax Practices (QETP) initiative is a collaborative, nationwide program seeking to identify employment tax schemes and illegal practices, as well as increase voluntary compliance with state and federal employment tax rules and regulations. The IRS, the National Association of State Workforce Agencies, the U.S. Department of Labor, the Federation of Tax Administrators and the state workforce agencies of California, Michigan, New Jersey, New York and North Carolina worked together to develop the QETP initiative.

For each worker who is an “employee,” a business must withhold and submit federal income taxes and, where applicable, state income taxes; withhold and pay Social Security and Medicare taxes; and pay state unemployment taxes based on wages. By comparison, the tax angle on “independent contractors” is a cakewalk: Employers do not have to withhold any money.

Independent contractors, who receive a Form 1099 and not a W-2 at the end of the year, must periodically declare and pay estimated taxes to both state and federal revenue authorities. For employers, the downside is the risk of misclassifying an employee as an independent contractor, in which case they will have to pay the owed taxes as well as a stiff penalty. As the IRS sees it, the difference between an employee and an independent contractor turns on whether the company controls the details of how the work or service is performed.

Worker classification is not the only arena of state and federal cooperation. Tax officials at both levels seek to uncover businesses “operating in the underground economy and making cash payments to workers and not reporting those payments to IRS and to the states,” a representative of the California Employment Development Department told The Wall Street Journal.