A worker is considered a contractor only if they have their own business. An example of a subcontractor is when someone contracted by the business performs work for it.

The Department of Labor and the IRS have begun a renewed effort to put an end to what they call decades of abuse by businesses and independent contractors. In this post I answer some common questions I have encountered since this new enforcement action has begun.

Q: Will someone get penalized if their employer asserts that they are a contractor but the IRS rules that they should be an employee?

A: Yes. The Department of Labor and the IRS have decided that if a person is working under someone else’s direction, that person is an employee. The contractor is considered an equal partner when negotiating the contract, so they share equal responsibility with the employer. If the IRS determines that they should have been a withholding employee, not only would they be liable for back taxes, they would incur penalties and interest.

Q: When you say “under someone else’s direction,” you must mean being required to be present for core hours or adhering to a set schedule, right?

A: Not anymore. The Department of Labor’s new standard is simple: If it is apparent that the relationship is an employer-employee one, then it is an employer-employee relationship. This is true even for contractors who work off site.

Q: Doesn’t withholding mean an automatic pay cut?

A: Former contractors should be happy to be converted to W2 employees. All of the labor laws that do not apply to contractors will now be in effect. That includes being paid overtime and being covered by unemployment insurance (at the employer’s expense), as well as workers compensation insurance. Social Security and Medicare taxes will be cut in half because the employer-employee relationship requires the employer to match the employee’s contribution. When an employer hires an employee, they deduct Social Security and Medicare and match them, whereas previously, as a contractor, the employee would have been liable for all taxes because contractors are self-employed.

Q: When filling out the paperwork to become an employee, what should people put down for the number of dependants?

A: That is different for every taxpayer, but it is important to note that the IRS expects you to know who is claiming you as a dependant before you name yourself. That largely depends on how you file – single, married, single filed jointly, or married filing jointly.

Q: Are domestic workers considered employees or contractors?

A: They are considered employees. A recent case illustrates this point, wherein a caregiver was penalized by the IRS because she was an employee while being paid as a contractor.

The government is convinced that businesses and contractors have been flouting the rules for years, and they are determined to make 2015 the year the party ends. Seeing a qualified CPA is the only way to ensure that you are not accumulating unpaid taxes, whether you are a contractor or not.

Are you a W2 employee or a contractor?