It is not uncommon to encounter a client with 1099-MISC income from an employer that is treating him or her as an independent contractor when your client is actually an employee.
The general distinction, of course, is that an employee is an individual who works under the direction and control of their employer while an independent contractor is a business owner or contractor who provides services to other businesses.
To determine whether a worker is an independent contractor or an employee, IRS examines the relationship between the worker and the business, and considers all evidence of control and independence. The facts that provide this evidence fall into the following three categories:
(1) Behavioral control covers facts that show whether the business has a right to direct and control how the work is done through instructions, training, or other means. Employees are generally given instructions on when and where to work, what tools to use, where to purchase supplies, what order to follow, etc.
(2) Financial control covers facts that show whether the business has a right to control the financial and business aspects of the worker's job. This includes the extent to which the worker has unreimbursed business expenses; the extent of his investment in the facilities being used; the extent to which he makes his services available to the relevant market; how he's paid; and the extent to which he can realize a profit or incur a loss.
(3) Type of relationship includes written contracts describing the relationship the parties intended to create; the extent to which the worker is available to perform services for other, similar businesses; whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay; the permanency of the relationship; and the extent to which services performed by the worker are a key aspect of the company's regular business.
The above three categories condense IRS’ 20-factor test used to help determine if the employer has direction and control over an individual.
Where the status is in doubt, Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be used. The form may be completed by an employer or a worker and asks the IRS to determine whether a worker is an employee or independent contractor for federal tax matters. Form SS-8 is to be filed separately from the requestor’s tax return. The IRS does not issue determinations for proposed employment arrangements or hypothetical situations, and will only issue a determination if the statute of limitations for the year at issue hasn’t expired.
For an employee to avoid having to pay SE tax on the 1099-MISC income when he or she has already been determined to be an employee or when the worker has filed an SS-8 and has not received a response, the individual files Form 8919, which only requires payment of what would have been withheld if the worker were treated as an employee. Form 8919 requires the employee to check one of these boxes:
Code A. I filed Form SS-8 and received a determination letter stating that I am an employee of this firm.
Code C. I received other correspondence from the IRS that states I am an employee.
Code G. I filed Form SS-8 with the IRS and have not received a reply.
Code H. I received a Form W-2 and a Form 1099-MISC from this firm [for the same tax year]. The amount on Form 1099-MISC should have been included as wages on Form W-2.
If code H is used, do not file an SS-8. Examples of amounts that are sometimes erroneously included, but not necessarily deliberately misclassified, on Form 1099-MISC that should be reported as wages on Form W-2 include employee bonuses, awards, travel expense reimbursements not paid under an accountable plan, scholarships, and signing bonuses.
If reason code G is used, the employee or the firm that paid the employee may be contacted for additional information. Use of this reason code is not a guarantee that the IRS will agree with the worker’s opinion as to his/her status. If the IRS does not agree that the worker is an employee, the worker may be billed for the additional tax, penalties, and interest resulting from the change to the worker’s status.
Where the IRS determination is for multiple open years, the employee can amend open years to recover a portion of the SE tax paid. Amend the open year by deleting the SE tax form and adding the Form 8919.