Employee or Independent contractor

Q. I am a painter and my boss says I am an independent contractor. He says I have to pay all my own taxes and my paycheck will be my total wages instead of minus taxes. Is that correct?

A. Unfortunately, I can’t make the distinction of whether or not you are actually an employee. I can tell you that in my experience many workers in the service industry like painters, plumbers and other laborers are incorrectly classified. The issue is the level of control exerted over your work. For a definitive answer, you can complete form SS-8 and send it to the IRS for review. I wrote an article about this topic that you can read here. For purposes of this blog, I will describe the effect of both scenarios from a tax perspective.

If you are truly an employee, then the employer matches what you contribute to Social Security and Medicare. Depending on your state, you could be eligible for health benefits. Your employer will also pay FUTA and SUTA (state and federal unemployment). Your state also requires that enmployers maintain some sort of workers compensation coverage in case you are injured on the job. As an employee, you get a certain level of protection again lay offs and on-the-job injury that the employer must pay for. You can see why certain companies try to skirt these requirements. They are expensive.

As an independent contractor, you are liable for self-employment taxes and have no work comp or unemployment insurance coverage in most cases. This means, the “employer” saves a ton of money. He also moves the risk off his own business and sticks it to the contractor. This also means that you the contractor must file quarterly estimated tax payments with the IRS or risk large penalty and interest payments. You are liable for all taxes.

In a mis-classified situation where you are actually an employee but considered a contractor by your “employer”, it is very likely that the “employer” is not paying tax on his/her income either. The IRS has identified this as a significant source of the so-called “tax gap” and is looking closely at ways to find and audit organizations in these industries.

Good luck on your quest. Ignorance is often the cause of misclassification. However, more often than not, it is an outright attempt to hide from the government in my opinion.

FUTA and SUTA

Q. As a small business owner looking forward to processing my own payroll, I am curious about FUTA and SUTA and how the calculation works.

A. First, congratulations on taking the step toward hiring employees. It can be both a good thing, because you are growing, and a bad thing, because employees bring new challenges to the business. To get started, let me say that all discussions regarding federal level taxes and withholdings that are the responsibility of the employer can be found in IRS Publication 15. FUTA is also discussed there.

FUTA stands for “Federal Unemployment Tax Act” and is a tax paid on the wages of employees by the employer. The tax is 6.2% of employee wages up to $7000 per employee. That equates to $434 per person per year. There is relief from this rate built in to the calculation. Per Pub 15, “Generally you can take a credit against your FUTA tax for amounts that you paid into state unemployment funds”. The credit is up to 5.4% which leaves your FUTA tax rate at .8% or $56 per employee per year. The credit has some stipulations and your state has to be in the good graces of the federal government for that to work. New York employers lost this credit a couple of years ago. Generally, if you pay your state unemployment tax on time, you get the credit.

SUTA is State Unemployment Tax Authority. It is essentially the state version of the federal unemployment tax. Each state has a wage base. Each new employer will be assigned a new employer rate that will adjust after 1 or 2 years of experience with employees. This is also a tax on wages paid by the employer. For instance, in Arizona, new employers pay 2% of wages up to $7000 or $140 per person per year. After some time has passed, the rate adjusts down if you have no unemployment claims or up if you do. Certain states have special starting rates depending on industry.