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Tax Rules for Independent Contractors

  Sanjiv Gupta CPA  Published 
Tax Rules for Independent Contractors

Are you clear about your employment status – whether you are an employee or an Independent Contractor (IC)? If you are not sure, then it is good that you check the IRS website to understand tax implications on these employment categories.

It is the duty of every citizen to pay taxes regularly no matter what the tax liability amount is. Of late, the IRS has been conducting a lot of scrutiny on Independent Contractors because it has been noted that in certain circumstances, employers are evading employment tax by classifying their employees as Independent Contractors.

Let us discuss more Independent Contractors, in the context of dental practices, to gain a better understanding of the employment classification mechanism. Independent Contractors are people who are self-employed. They are specialists in their area, own their own dental practice, perform their work duties from their premises, bring and purchase their work materials and supplies, work at their will, pay for their own staff, in case they employ people to work for them, and ultimately control the quality of their work or output that is to be delivered. Broadly speaking the ICs maintain a contract with the entity and not with the person providing the service. Hence, it is a contract between two entities. There is strictly no employer-employee relationship in this context.

An employee is one work for an owner, perform services as mandated by the owner, work during the hours fixed by the owner, adhere to output quality set by the owner, use the equipment and supplies of the owner to provide the designated service and ultimately is supervised by the owner throughout the job duration. A dental associate is a classic example of this category. An associate works for a specialist or an independent contractor and draws a monthly salary for offering services. There is a clear employer-employee relationship in this context.

Misrepresenting or misclassifying employees as ICs either intentionally or by ignorance is a serious offense and is punishable by law. IRS heavily penalizes owners who adopt such practices to evade taxes. Consequences for an owner who misclassifies employees are:

  1. Scrutiny of the employer’s social security and Medicare tax liability

  2. Scrutiny of Federal unemployment tax paid

  3. Penalties an interest in general and specifically on any employee benefit plans

There are a number of cases that fall under this category of misrepresentation. If the IRS detects the case to be an abuse of classification the owner could face grave consequences. On such example is the case of a stockbroker. All the stockbrokers of this small firm were where treated as independent contractors by the owner of the firm. When the IRS audited this brokerage firm, all the brokers had to prove that they were paying self-employment taxes and also had to provide a copy of their returns to ascertain that they were reporting their income accurately. Ultimately the brokerage firm was penalized hundreds of thousands of dollars on back payroll taxes and interest.

Since the results of an IRS audit could be grave, in case of malpractice or abuse of employee classification, it is best for businesses in their own interest to be transparent and straight forward in cases related to employee classification.