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Employment taxes, part 2: the issue of worker classification

Last week we began discussing the rather complicated topic of employment taxes.

As we noted, the term “employment taxes” is often used interchangeably with another term, payroll taxes.

But the complexity concerning these taxes does not really come from the use of these synonyms. It comes from the fact that employment taxes refer to several different tax responsibilities that employers have.

These responsibilities do not only encompass federal income tax withholding, Social Security taxes and Medicare taxes. They also include federal unemployment taxes.

In this part of the post, let’s delve in more detail into Social Security and Medicare taxes.

These two taxes are closely related because they are both imposed by the same federal law. That law is the Federal Insurance Contributions Act (FICA).

These taxes generally apply to wages paid to employees in the United States. This normally remains the case regardless of the residency or citizenship status of the employer or employee.

Employers are required to make deductions for these taxes from wage payments.

Of course, the tricky question that can easily arise is whether a particular worker has the status of employee or is merely an independent contractor. The FICA withholding requirements do not apply to contractors.

For years, the issue of worker classification has weighed on employers. On the one hand, there are strong financial pressures to keep employee headcount down by using contractors rather than employees.

But on the other hand, the IRS has been scrutinizing employers closely for possible worker misclassification. The IRS often audits employers, seeking to detect instances of employees who are wrongly classified as contractors.

Even if the IRS finds misclassification, that does not necessarily mean a particular employer intended to evade the law.

After all, determining employee status involves the consideration of many different factors. That is why the IRS devotes considerable space in its tax guide for employers to the question: who are employees?

Source: IRS.gov, "Publication 15, (Circular E), Employer's Tax Guide," Accessed May 15, 2014

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