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Addressing Federal and State Tax Issues Related to Worker Classification

Posted on in Taxation Law

san jose tax lawyerBusiness owners may need to address a variety of tax matters, and one important issue involves the classification of workers as either employees or independent contractors. Employers who classify workers incorrectly could face penalties, or they may be required to pay certain types of employment taxes at the federal and state levels. By understanding the rules for classifying workers, business owners can be sure they are in compliance with all applicable tax laws.

Federal Worker Classification Rules

Employers will need to withhold and pay certain types of federal taxes on behalf of employees, including income taxes, Social Security taxes, and unemployment taxes. However these taxes do not need to be withheld for independent contractors. The IRS looks at three issues to determine whether a worker should be classified as an employee or independent contractor:

  • Behavioral control - If a company controls how a worker performs their job, such as the hours and locations they work and whether they can work for other companies, they will be more likely to be considered an employee.

  • Financial control - How wages, expenses, and other financial issues are handled may affect a worker’s classification. These issues may include whether and how a worker is reimbursed for expenses and whether they own their own tools and equipment or use equipment provided by the employer.

  • Relationship between worker and employer - Classification may depend on the length of time a person works for an employer, whether their work is a key aspect of the business, and whether any other agreements exist between the worker and the employer, such as the ability to receive benefits.

If workers have been misclassified, an employer may participate in the Voluntary Classification Settlement Program (VCSP). This will allow them to reclassify workers as employees, and they may qualify for partial relief from some federal employment taxes.

Worker Classification in California Under AB5

The State of California passed Assembly Bill 5 in 2019, and this law created an “ABC” test to determine whether workers are classified as employees or independent contractors for state employment tax purposes. Under the ABC test, a worker can be considered an independent contractor only if they satisfy all three of the following requirements:

  • The employer does not have control over how a worker performs work.

  • The work performed by a worker is not part of the “usual course” of an employer’s business.

  • The worker has an independent trade or business of the same nature as the work they perform for an employer.

While these requirements are very strict, several challenges to AB5 have been brought since 2019 that have focused on exempting certain types of workers from the ABC test or putting other requirements in place. To ensure that they are classifying workers correctly and avoiding potential tax penalties, employers can consult with an attorney who has a strong understanding of the California employment tax laws.

Contact our San Jose, CA Employment Tax Attorney

At John D. Teter Law Offices, we can answer your questions about worker classification, and we can ensure that you are meeting your requirements under federal and state tax laws. To get legal help with matters related to employment taxes, contact our San Jose tax lawyer at 408-866-1810.

Sources:

https://www.irs.gov/newsroom/irs-reminds-business-owners-to-correctly-identify-workers-as-employees-or-independent-contractors

 

https://www.ftb.ca.gov/file/business/industries/worker-classification-and-ab-5-faq.html

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