Module 13Employee vs

Independent Contractor

Employee (E’e) vs Independent Contractor (IC)

Key Learning Objectives

Income and payroll taxes withholding Coverage under certain federal laws Fringe benefits

Employees Only--Income & Payroll Tax Withholding

Income tax withholding Social Security and Medicare taxes Federal unemployment

taxes

Employees Only Protected By Some Laws

Minimum working condition standards Minimum wages and overtime pay The right to collective bargaining Pension benefits Civil Rights Act of 1964 Age Discrimination in Employment Act

Employees Only Entitled to Fringe Benefits

Fringe benefits Group medical insurance coverageGroup medical insurance coverage Group life insurance coverageGroup life insurance coverage Participation in an employer's cafeteria plan Participation in an employer's cafeteria plan Payment for sick and vacation daysPayment for sick and vacation days

Employees and Wages

Key Learning Objectives Determining who are employees Determining which wages are subject to

Withholding of income taxesWithholding of income taxes Social Security and Medicare taxesSocial Security and Medicare taxes

TaxPoint: Workers Reclassified on Audit

Between 1988 and 1995Between 1988 and 1995 IRS completed 12,896 payroll auditsIRS completed 12,896 payroll audits $830 million in recommended tax assessments$830 million in recommended tax assessments 527,000 workers reclassified to E’e status527,000 workers reclassified to E’e status

Worker Employee If

Person paying for services Has right to control Has right to control Has right to direct details and means by Has right to direct details and means by

which the result is accomplishedwhich the result is accomplished Does not have to actually direct or Does not have to actually direct or

control ; control ; just have the right to do so just have the right to do so

Worker Employee If

Person being paid is subject to the will and control of the payer as to What work has to be doneWhat work has to be done How the work must be doneHow the work must be done

Withholding & Employment Taxes

Applied to includable wagesApplied to includable wages Current compensationCurrent compensation Non-excluded fringe benefitsNon-excluded fringe benefits Compensation related interest free loansCompensation related interest free loans

Current Compensation

Cash and FMV of property Tips , bonuses, and most awards Sick /Severance pay Personal use of property e.g. autos Personal expenses paid for self or family Moving expenses paid by E'r if not

"Qualified" Unemployment benefits Non-excluded fringe benefits

Excluded Fringe Benefits(Some require non-discrimination)

1st $50,000 of group term life insurance Accident/health insurance premiums Reimbursement/medical care Reimbursement/qualified moving

expenses Reimbursement/accountable plan for

business expenses Qualified employee discounts

Excluded Fringe Benefits(Some require non-discrimination)

No additional cost services Working condition fringes

DeMinimus fringes Qualified transportation fringe Meals/lodging for Employer’s convenience On-premises athletic facilities Reduced tuition for education Otherwise excluded selected through

cafeteria plan

Compensation Related Compensation Related Interest Free LoansInterest Free Loans

Interest income/expense must be imputed Imputed amount is subject to withholding

Income taxes Employment taxes

Tax Obligations of an Employer

Key Learning Objectives

Income tax withholding Social Security and Medicare taxes Federal Unemployment Taxes (FUTA)

Income Tax Withholding

E’r required toE’r required to withhold federal/state withhold federal/state

individual income tax individual income tax from wagesfrom wages

deposits money on deposits money on required due datesrequired due dates

may be required to file may be required to file electronicallyelectronically

file quarterly Form 941file quarterly Form 941 file annual W2file annual W2

E’e files Form W4 to E’e files Form W4 to establish withholding establish withholding amountamount

Social Security and Medicare(Employment taxesEmployment taxes))

E’r and E’e pay equal sharesE’r and E’e pay equal shares E’e share is withheld from payE’e share is withheld from pay `E’r deposits both halves on required due dates`E’r deposits both halves on required due dates

may be required to file electronicallymay be required to file electronically

2000 rates2000 rates for eachfor each 6.20% on first $76,200 of included 6.20% on first $76,200 of included

wageswages 1.45% on each included dollar 1.45% on each included dollar

Federal Unemployment Taxes

Provides payments to workers who have lost their jobs

Employee does not include An insurance salesperson ORAn insurance salesperson OR An individual who works at homeAn individual who works at home

Special rules for some classes of employeesSpecial rules for some classes of employees

Federal Unemployment Taxes

E’r E’r onlyonly required to pay to state and federal required to pay to state and federal Base = $7,000 of wages per employeeBase = $7,000 of wages per employee Rate = 6.2% of base Rate = 6.2% of base

Reduced by credit for up to 5.4% of state Reduced by credit for up to 5.4% of state unemployment tax paid unemployment tax paid

E’r deposits money on required due datesE’r deposits money on required due dates E’r may be required to file electronicallyE’r may be required to file electronically

E’r files annual Form 940 or 940EZE’r files annual Form 940 or 940EZ

Compliance Query: Calculation of Payroll Taxes

Chris receives the following from employerChris receives the following from employer Cash salary Cash salary $100,000$100,000 Heath insurance premiumsHeath insurance premiums $5,000 $5,000 E’r contributions to qualifiedE’r contributions to qualified

retirement planretirement plan $10,000 $10,000 What is FICA/Medicare liability for What is FICA/Medicare liability for

Chris?Chris? Chris’s employer?Chris’s employer?

Use 2000 amountsUse 2000 amounts

Solution--Compliance Query: Total Cost = $12,348.80 ,348.80

Exclude from wage baseExclude from wage base Heath care premiums paid by E’rHeath care premiums paid by E’r E’r contributions to qualified retirement plansE’r contributions to qualified retirement plans

Wages subject to payroll taxes = $100,000Wages subject to payroll taxes = $100,000 Maximum FICA base for 2000 is $76,200Maximum FICA base for 2000 is $76,200 FICA FICA = $ 76,200 * .062 = $4,724.40 = $ 76,200 * .062 = $4,724.40 Medicare = $100,000 * .0145 = Medicare = $100,000 * .0145 = $1,450.00$1,450.00 Chris & E’r pay same amountChris & E’r pay same amount $6,174.40$6,174.40

Tax Consequences for Independent Contractor

Key Learning Objectives

Payroll taxes (self-employment taxes) Schedule C Estimated tax payments

Self-Employment Taxes(Payroll Taxes)

Wage base is all earnings net of allowable Wage base is all earnings net of allowable deductionsdeductions

Wage base is reduced to 92.35%Wage base is reduced to 92.35% 12.4 % 12.4 % OASDI OASDI (FICA equivalent)(FICA equivalent)

$76,200 maximum base in 2000$76,200 maximum base in 2000 2.9% Medicare 2.9% Medicare

No maximum ceilingNo maximum ceiling

Compliance Query: Payroll Taxes for Independent Contractor

Chris, an independent contractor, receives Chris, an independent contractor, receives $123,000 for services rendered $123,000 for services rendered

Chris pays the following from the $123,000Chris pays the following from the $123,000 Allowable business expenses $8,000Allowable business expenses $8,000 Heath insurance premiums Heath insurance premiums $5,000 $5,000 Contributions to qualifiedContributions to qualified

retirement retirement planplan $10,000 $10,000

What is Chris’ SE tax liability for 2000?What is Chris’ SE tax liability for 2000?

Solution--Compliance Query: Total cost = $12,528.6912,528.69

Only allowable business expenses excludedOnly allowable business expenses excluded Wages subject to payroll taxes = $106,203Wages subject to payroll taxes = $106,203

(123,000-8,000) x .9235(123,000-8,000) x .9235 OASDI (FICA) OASDI (FICA) = $ 76,200 x .124 = $9,448.80 = $ 76,200 x .124 = $9,448.80 MedicareMedicare = $106,203 x .029 = $3,079.89 = $106,203 x .029 = $3,079.89 Additional deductions FOR AGIAdditional deductions FOR AGI

60% (2000) of medical premiums 60% (2000) of medical premiums (No E’r coverage)(No E’r coverage)

Qualified pension plan contributionsQualified pension plan contributions 1/2 SE TAX1/2 SE TAX

Tax Planning Query: Become An Independent Contractor?

Andy would like to quit her job and be her own Andy would like to quit her job and be her own womanwoman

Andy currently works 2,000 hours a year forAndy currently works 2,000 hours a year for Cash salary Cash salary $100,000$100,000 Heath insurance premiumsHeath insurance premiums $5,000 $5,000 E’r contributions to qualifiedE’r contributions to qualified

retirement planretirement plan $10,000 $10,000

Andy feels that she could charge $65 per hour and Andy feels that she could charge $65 per hour and would be able to bill 2,000 hourswould be able to bill 2,000 hours

If she quits, will she be in a better or worse financial If she quits, will she be in a better or worse financial position?position?

Tax Planning Query: Become an Independent Contractor? (con’t)

Assumptions:Assumptions: Andy is single & does not itemizeAndy is single & does not itemize 2000 tax year2000 tax year

single standard deduction = $4,400single standard deduction = $4,400 1 exemption = $28700 1 exemption = $28700

Medical premiums remain the sameMedical premiums remain the same No additional costs of doing business asNo additional costs of doing business as

independent contractorindependent contractor

Become An Independent Contractor? (con’t)

Step One Step One Calculate the income tax due if an employeeCalculate the income tax due if an employee

Gross income Gross income $100,000$100,000

Deductions for AGI Deductions for AGI 0 0

AGIAGI $100,000 $100,000

Deductions from AGIDeductions from AGI 7 ,200 7 ,200 (2,800 +4,400)(2,800 +4,400)

Taxable Income Taxable Income $ 92,800$ 92,800

Income TaxIncome Tax $23,449 $23,449

Become An Independent Contractor? (con’t)

Step TwoStep Two Calculate the payroll taxes paid if an employeeCalculate the payroll taxes paid if an employee

FICA TaxesFICA Taxes $76,200 x .062 $76,200 x .062 $4,724 $4,724

Medicare $100,000 x .0145 Medicare $100,000 x .0145 1,450 1,450

Step Three:Step Three: Calculate net cash from being an employeeCalculate net cash from being an employee $70,377 = 100,000 - 23,449 - 4,724 -1,450$70,377 = 100,000 - 23,449 - 4,724 -1,450

Become An Independent Contractor ?? (con’t)

Step Four:Step Four: Calculate gross income from being SECalculate gross income from being SE $65 per hour x 2,000 hours = $130,000 $65 per hour x 2,000 hours = $130,000

Become An Independent Contractor? (con’t)

Step Five:Step Five: Calculate the payroll taxes paid if an employeeCalculate the payroll taxes paid if an employee SE wage base is reduced to 92.35%SE wage base is reduced to 92.35% FICA equivalent increased to 12.4% on $76,200 FICA equivalent increased to 12.4% on $76,200 Medicare increased to 2.9% Medicare increased to 2.9%

FICA Taxes $76,200 x .124 FICA Taxes $76,200 x .124 = $9,449 = $9,449 Medicare $130,000 x .9235 x .029 = Medicare $130,000 x .9235 x .029 = 3,4823,482

$12,931$12,931

Become An Independent Contractor ?? (con’t)

Step Six: Step Six: Calculate the income taxes due if self employedCalculate the income taxes due if self employed 60% of medical deductible for AGI in 200060% of medical deductible for AGI in 2000 50% of total SE taxes deductible for AGI50% of total SE taxes deductible for AGI Retirement contribution deductible for AGIRetirement contribution deductible for AGI

Become An Independent Contractor? (con’t)

Gross income Gross income $130,000$130,000

Deductions for AGIDeductions for AGI

RetirementRetirement 10,000 10,000

60% Medical60% Medical 3,000 3,000

50% SE Tax 50% SE Tax $12,931$12,931 6,4666,466

AGIAGI $110,534$110,534

Deductions from AGIDeductions from AGI 7 ,200 7 ,200 (2,800 +4,400)(2,800 +4,400)

Taxable Income Taxable Income $ 103,334$ 103,334

Income TaxIncome Tax $26,715 $26,715

Become An Independent Contractor? (con’t)

Step Seven:Step Seven: Calculate net cash from being self-employedCalculate net cash from being self-employed $75,354 = 130,000 - $75,354 = 130,000 - $26,715- $12,931 - 15,000 $12,931 - 15,000

(medical and retirement) (medical and retirement) Step Eight:Step Eight:

Compare with net cash from being employee Compare with net cash from being employee $75,354 - $70,377 = $4,977$75,354 - $70,377 = $4,977

Become An Independent Contractor? (con’t)

Andy will make about $2.48 more an hour Andy will make about $2.48 more an hour as a self-employed person. as a self-employed person.

§530 Relief

Key Learning Objectives Requirements for obtaining §530 relief Benefits of obtaining §530 relief

§530 Relief Available If Taxpayer

Has never treated individual as an employee Files all required Federal tax returns on a

basis consistent with individual as a nonemployee, AND

Has a reasonable basis for not treating the individual as an employee

§530 relief NOT available for skilled workers hired through technical service firms.

§530 Relief--Extends to E’r Only

Relief applies to E’r liability to withhold Income tax Income tax Social Security tax Social Security tax

Relief applies to E’r liability to pay Social Security tax Social Security tax Unemployment taxUnemployment tax

Interest or penalties automatically forgiven E’e remains liable for taxes

TaxPoint: Classification Settlement Program (CSP) & New Training Programs for IRS CSP designed to allow taxpayers to resolve CSP designed to allow taxpayers to resolve

worker classification issues worker classification issues Taxpayer can pay part of back taxes and agree Taxpayer can pay part of back taxes and agree

to proper treatment in futureto proper treatment in future Retraining stresses that qualifying taxpayers Retraining stresses that qualifying taxpayers

should be informed that §530 relief may should be informed that §530 relief may apply apply