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VCSP CPA discusses classifying Workers | Subcontractors and Employees

Gary Bode: VCSP is an interesting IRS "sale." For a free phone consult, call 399-2705.

VCSP (Voluntary Classification Settlement Program) CPAs get plenty of questions about exactly what criteria the IRS uses for classifying subcontractors and employees. So, let’s look at this core issue.

VCSP Background

We’ve published several VCSP posts including:

”The IRS loses millions in employment taxes on workers classified as independent contractors but are actually, by IRS definition, employees.”
Gary Bode, VCSP CPA and Payroll Accountant

Employee vs. Subcontractor: What’s at Stake?

Let’s look at this issue from the perspective of the CPA for our demo company, Wilmington NC CPA Firm. WNCF pays three people as independent contractors, for a convenient aggregate total of $100,000 per year. WNCF pays no employment or unemployment taxes on these folks. Instead they receive a Form 1099-MISC. The independent contractors must declare this as income on their own tax returns. If Wilmington NC CPA Firm paid these three folks as employees, the additional costs would be:

  • $6,200 of Social Security employer “matching” taxes.
  • $1,450 of Medicare employer “matching” taxes.
  • $168 of Federal Unemployment taxes (FUTA).
  • Approximately $700 of NC unemployment tax (SUTA).

So, WNCF would have had to pay an additional $8,518 just in taxes for the aggregate $100,000 compensation on these three independent contractors, if they were employees. And that’s not the whole financial picture either. They also save health insurance premiums, 401(k) contributions, sick pay, vacation pay etc. So, there is good financial incentive to classify workers as subcontractors instead of employees.

So what is an Employee?

The following criteria factor into who the IRS considers as employees. There is a no cut and dried answer. Each case is unique. Plus the importance of each of these factors differs in every case. While the following list is common knowledge, this exact version comes from an excellent white paper put out by CFO magazine.

1. Instructions. A worker who complies with other persons’ instructions about when, where and how he or she is to work ordinarily is an employee.

2. Training. Training a worker indicates that the person(s) for whom the services are performed wants the services performed in a particular method or manner.

3. Integration. Integration of the worker’s services into the business operations generally shows that he worker is subject to direction and control.

4. Services Rendered Personally. If the services must be rendered personally, presumably the person(s) for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.

5. Hiring, supervising and paying assistants. If the person(s) for whom the services are performed hire, supervise and pay assistants, this generally shows control over the workers on the job.

6. Continuing Relationship. A continuing relationship between the worker and the person(s) for whom the services are performed indicates that an employer-employee relationship exists.

7. Set Hours of Work. The establishment of set work hours is a factor indicating control.

8. Full-Time Work Required. If the worker must devote substantially full time to the business of the person(s) for whom the services are performed, such person(s) have control over the amount of time the worker spends working restricts the worker from doing other gainful work.

9. Doing Work on Employer’s Premises. If the work is performed on the premises of the person(s) for whom the services are performed, this suggests control over the worker, especially if the work could be done elsewhere.

We’re a Wilmington NC CPA firm that deals with VCSP and Form 8951. Our virtual office allows us to provide excellent long distance service. Our posts demonstrate our expertise and proactive philosophy. For a free phone consult, please call (910) 399-2705.

The following is cut and pasted from the IRS website.

  1. Order or Sequence Set. If a worker must perform services in the order or sequence set by the person(s) for whom the services are performed, the worker is not free to follow the worker’s own pattern of work but must follow the established routines and schedules of the person(s) for whom the services are performed.
  2. Oral or Written Reports. A requirement that the worker submit regular or written reports to the person(s) for whom the services are performed indicates a degree of control.
  3. Payment by Hour, Week, Month. Payment by the hour, week or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of applying a lump sum agreed upon as the cost of a job.
  4. Payment of Business and/or Travel Expenses. If the person(s) for whom the services are performed ordinarily pays the worker’s business and/or traveling expenses, the worker generally is an employee.
  5. Providing Tools and Materials. The fact that the person(s) for whom the services are performed provides significant tools, materials and other equipment tends to show the existence of an employer-employee relationship.
  6. Significant Investment. A lack of investment in facilities indicates dependence on the person(s) for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship.
  7. Realization of Profit or Loss. A worker who can realize a profit or suffer a loss as a resultof the worker’s services (in addition to the profit or loss ordinarily realized by employees) generally is an independent contractor, but the worker who cannot is an employee.
  8. Working for More Than One Firm at a Time. A worker that performs more than de minimis services for a multiple of unrelated persons or firms at the same time generally indicates that he or she is an independent contractor. However,a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
  9. Making Services Available to General Public. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
  10. Right to Discharge. The right to discharge a worker is a factor indicating that the worker is an employee. In contrast, an independent contractor cannot be fired so long as he or she produces a result that meets the contract specifications.
  11. Right to Terminate. An employer-employee relationship is indicated if the worker has the right to end his or her relationship with the person(s) for whom the services are performed at any time he or she wishes without incurring liability.

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