Home agency reasonably treated workers as independent contractors.

• Author: Gordon, Tim

Who qualifies as an independent contractor?

With today's changing business landscape, the answer is not always black and white. Between the provisions of the Patient Protection and Affordable Care Act, P.L. 111-148, and the rise of the "sharing economy," independent contractor classification is making headline news. And woe to the company that gets the answer wrong, since it can lead to a painful assessment from the IRS.

Nelly Home Care Inc. recently ran into a problem with this issue. The IRS disagreed with Nelly's independent contractor classification and assessed back taxes under Sec. 3509(a). This happened even though Nelly made an upfront effort to properly classify its workers. Fortunately, Nelly found tax relief {Nelly Home Care, Inc., No. 15-439 (E.D. Pa. 5/10/16)). This case serves as both a warning and a guiding light for any employer looking to classify its workers as independent contractors.

Overview of Sec. 3509(a)

Under Sec. 3509(a)(1), if an employer misclassifies an employee, that employer will face a back withholding tax liability "equal to 1.5 percent of the wages ... paid to such employee," assuming that the employer followed all the correct reporting requirements for an independent contractor. If the employer did not follow the correct procedures, the amount due doubles to 3% of the wages paid to the employee (Sec. 3509(b)(1)(A)).

Example: A hires B for $40,000, treating B as an independent contractor. The IRS determines that A should have treated B as an employee. Assuming A filed B's Form 1099-MISC, Miscellaneous Income, and followed the other rules related to independent contractors, A will owe $600 to the IRS, or 1.5% of $40,000. If A did not correctly follow the independent contractor rules, that amount doubles to $1,200.

Similarly, under Sec. 3509(a)(2), if an employer misclassifies an employee, the employer will face a back Social Security tax in the amount of 20% of the employee's FICA tax liability if he or she had been treated as an employee, assuming that the employer followed all the correct reporting requirements for an independent contractor. If the employer did not follow the correct procedures, the amount due doubles to 40% of the employee's share of FICA tax liability if he or she had been treated as an employee (Sec. 3509(b)(1)(B)).

If an employer has multiple misclassified employees over many years, the tax bill can be quite large. Sec. 3509(a) requires the payment of these taxes notwithstanding the...