If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees.

Why It Matters

The Internal Revenue Service and state regulators scrutinize the distinction between employees and independent contractors because many business owners try to categorize as many of their workers as possible as independent contractors rather than as employees. They do this because independent contractors are not covered by unemployment and workers' compensation, or by federal and state wage, hour, anti-discrimination and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.

Caution: If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty

The Difference Between Employees and Independent Contractors

Independent Contractors are individuals who contract with a business to perform a specific project or set of projects. You, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.

Example: Sam Smith, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. He is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if he works more or less than 400 hours to complete the work, Sam will receive $6,400. He also performs additional electrical installations under contracts with other companies, that he obtained through advertisements. Sam Smith is an independent contractor.

Employees provide work in an ongoing, structured basis. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. A worker is still considered an employee even when you give them freedom of action. What matters is that you have the right to control the details of how the services are performed.

Example: Sally Jones is a salesperson employed on a full-time basis by Rob Robinson, an auto dealer. She works 6 days a week, and is on duty in Rob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Rob. Rob also pays the cost of health insurance and group-term life insurance for Sally. Sally Jones is an employee of Rob Robinson.

Independent Contractor Qualification Checklist

The IRS, workers' compensation boards, unemployment compensation boards, federal agencies, and even courts all have slightly different definitions of what an independent contractor is, though their means of categorizing workers as independent contractors are similar.

One of the most prevalent approaches used to categorize a worker as either an employee or independent contractor is the analysis created by the IRS. The IRS considers the following:

1. What instructions the employer gives the worker about when, where and how to work. The more specific the instructions and the more control exercised, the more likely the worker will be considered an employee.

2. What training the employer gives the worker. Independent contractors generally do not receive training from an employer.

3. The extent to which the worker has business expenses that are not reimbursed. Independent contractors are more likely to have unreimbursed expenses.

4. The extent of the worker's investment in the worker's own business. Independent contractors typically invest their own money in equipment or facilities.

5. The extent to which the worker makes services available to other employers. Independent contractors are more likely to make their services available to other employers.

6. How the business pays the worker. An employee is generally paid by the hour, week or month. An independent contractor is usually paid by the job.

7. The extent to which the worker can make a profit or incur a loss. An independent contractor can make a profit or loss, but an employee does not.

8. Whether there are written contracts describing the relationship the parties intended to create. Independent contractors generally sign written contracts stating that they are independent contractors and setting forth the terms of their employment.

9. Whether the business provides the worker with employee benefits, such as insurance, a pension plan, vacation pay or sick pay. Independent contractors generally do not get benefits.

10. The terms of the working relationship. An employee generally is employed at will (meaning the relationship can be terminated by either party at any time). An independent contractor is usually hired for a set period of time.

11. Whether the worker's services are a key aspect of the company's regular business. If the services are necessary for regular business activity, it is more likely that the employer has the right to direct and control the worker's activities. The more control an employer exerts over a worker, the more likely it is that the worker will be considered an employee.

Minimize the Risk of Misclassification

If you misclassify an employee as an independent contractor, you may end up before a state taxing authority or the IRS. Sometimes the issue comes up when a terminated worker files for unemployment benefits and it's unclear whether the worker was an independent contractor or employee. The filing can trigger state or federal investigations that can cost many thousands of dollars to defend, even if you successfully fight the challenge.

There are ways to reduce the risk of an investigation or challenge by a state or federal authority. At a minimum, you should:

Familiarize yourself with the rules. Ignorance of the rules is not a legitimate defense. Knowledge of the rules will allow you to structure and carefully manage your relationships with your workers to minimize risk.

Document relationships with your workers and vendors. Although it won't always save you, it helps to have a written contract stating the terms of employment.

If you employ someone to work for you around your house, it is important to consider the tax implications of this arrangement. While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties. As you will see, these rules are quite complex, even for such a relatively minor employee, and a mistake can bring on tax headaches.

Who is a Household Employee?

The "nanny tax" rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

1. Household work is work done in or around your home by baby sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.

2. A household worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full time or part time, or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job. On the other hand, if only the worker can control how the work is done, the worker is not your employee, but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Betty to baby sit your child and do light housework four days a week in your home. Betty follows your specific instructions about household and child care duties. You provide the household equipment and supplies that Betty needs to do her work. Betty is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

Can Your Employee Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ an alien who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete the employee part of the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. You must verify that the employee is either a U.S. citizen or an alien who can legally work and then complete the employer part of the form. Keep the completed form for your records.

Tip: Two copies of Form I-9 are contained in the INS Handbook for Employers. Call the INS at 1- 800-755-0777 to order the handbook or additional copies of the form or to get more information.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or you may need to do both. To find out, read the table below.

Note: If neither of the two contingencies applies, you do not need to pay any federal unemployment taxes. But you may still need to pay state unemployment taxes.

You do not need to withhold federal income tax from your household employee's wages. But if your employee asks you to withhold it, you can choose to do so.

Tip: If your household employee cares for your dependent who is under age 13 or your spouse or dependent who is not capable of self care, so that you can work, you may be able to take an income tax credit of up to 30% of your expenses. If you can take the credit, you can include your share of the federal and state employment taxes you pay, as well as the employee's wages, in your qualifying expenses.

State Unemployment Taxes

You should contact your state unemployment tax agency to find out whether you need to pay state unemployment tax for your household employee. You should also find out whether you need to pay or collect other state employment taxes or carry workers' compensation insurance.

Note: If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this publication does not apply to you.

Social Security And Medicare Taxes

Both you and your household employee may owe Social Security and Medicare taxes. The taxes for each of you are 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee's Social Security and Medicare wages. You are responsible for payment of your employee's share of the taxes as well as your own. You can either withhold your employee's share from the employee's wages or pay it from your own funds. Note the limits on the table above.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

1. Your spouse.

2. Your child who is under age 21.

3. Your parent.

Note: However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks in a calendar quarter.

4. An employee who is under age 18 at any time during the year.

Note: However, you should count these wages to an employee under 18 if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee's Social Security and Medicare wages reach $102,000 in 2008 ($97,500 in 2007), do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. (But continue to count the employee's cash wages as Medicare wages to figure Medicare tax.) You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

• Meals provided at your home for your convenience.

• Lodging provided at your home for your convenience and as a condition of employment.

• Up to $115 a month in 2008 for bus or train tokens (passes) that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit.

• Up to $220 a month in 2008 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

As you can see the tax considerations for household employees are complex. Therefore, professional tax guidance is highly recommended. Please contact us for further information.

Filing a past due return may not be as difficult as you think. Getting it done for the 2007 tax year is important because in order to receive your economic stimulus payment this year you need to file a 2007 federal tax return by October 15. Remember, a delay in filing your tax return will also delay your receipt of your economic stimulus payment since payments are based on the tax return. You can still receive one this year if you file by October 15, 2008.

Taxpayers should file all tax returns that are due, regardless of whether or not full payment can be made with the return. Depending on an individual’s circumstances, a taxpayer filing late may qualify for a payment plan. All payment plans require continued compliance with all filing and payment responsibilities after the plan is approved. It is important, however, to know that full payment of taxes saves you money.

Here’s What to Do:

Gather Past Due Return Information

In order for the IRS to assist with preparing a tax return, taxpayers should bring any and all information related to income and deductions for the tax years for which a return is required to be filed.

Prepare and File Forms

You’ll need to get the proper forms and publications. Then sign and date your tax return; and send to the correct address.

Payment Options - Ways to Make a Payment

There are several different ways to make a payment on your taxes. Payments can be made by credit card, electronic funds transfer, check, money order, cashier’s check, or cash.

Getting Free Help

The IRS offers free assistance by computer, telephone, facsimile and in person. The IRS can assist taxpayers with obtaining forms, publications, and answers to a wide range of tax questions.

Payment Options - Ways to Make a Payment

There are several different ways to make a payment on your taxes. Payments can be made by credit card, electronic funds transfer, check, money order, cashier’s check, or cash.

Payment Options – For Those Who Can’t Pay in Full

Taxpayers who need more time to pay can find out in just a few minutes whether they qualify for a payment agreement with the IRS. Just click on the Online Payment Agreement link and follow the prompts. By entering some basic information about their tax situation, eligible taxpayers can set up in a matter of minutes either a short-term payment extension or a monthly payment plan.

A short-term extension gives a taxpayer up to 120 days to pay. No fee is charged, but the late-payment penalty plus interest will apply.

A monthly payment plan or installment agreement gives a taxpayer more time to pay. Though interest still applies, the late-payment penalty is cut in half for any month an installment agreement is in effect. This reduced rate of 0.25 percent (1/4 of 1 percent) per month is only available if the tax return was filed on time.

A user fee will also be charged if the installment agreement is approved. The fee, normally $105, is reduced to $52, if taxpayers agree to make their monthly payments electronically through electronic funds withdrawal. The fee is $43 for eligible low-and-moderate-income taxpayers.

Alternatively, taxpayers can apply for a payment agreement by filling out Form 9465, Installment Agreement Request. This form can be filed along with either an electronically filed return or a paper return. If filing on paper, be sure to attach it to the front of the return.

Taxpayers Eligible for Extra Time without Penalties or Interest

Some taxpayers can wait until after April 15 to file and pay. As a general rule, those eligible get the extra time penalty-free and interest-free without having to ask for it. Eligible taxpayers include:

• Members of the military serving in Iraq, Afghanistan or other combat-zone localities. Normally, the filing and payment deadline is postponed until 180 days after the service member leaves the combat zone.
• Disaster-area taxpayers in four states affected by recent floods, storms and tornadoes. The filing and payment deadline is postponed until May 6 in parts of Illinois, May 19 in parts of Georgia and Missouri and May 27 in parts of Arkansas.

What Will Happen If You Don’t File Your Past Due Return or Contact the IRS

It’s important to understand the ramifications of not filing a past due return and the steps that the IRS will take. Taxpayers who continue to not file a required return and fail to respond to IRS requests for a return may be considered for a variety of enforcement actions. Please contact us for further information and support on your late returns.

Economic stimulus payments will be issued according to the last two-digits of the main filer’s Social Security number. People who use direct deposit also will be among the first to receive the payments starting May 2. Paper checks will be put in the mail starting May 16.

DIRECT DEPOSIT

PAPER CHECK

People who file a return after April 15 will receive their economic stimulus payment, but probably about two weeks later than the schedule shows. A return must be filed by October 15 in order to receive a stimulus payment this year. See the online calculator for an estimate of the amount you will receive.

A small percentage of tax returns will require additional time to process and to compute a stimulus payment amount. For these returns, stimulus payments may not be issued in accordance with the schedule above, even if the tax return was processed by April 15.

The IRS announced it will issue guidance for businesses on how the special 50 percent depreciation allowance that was included in the Economic Stimulus Act of 2008 can be used to make capital investments this year. Until the guidance is issued, businesses may rely on the regulations previously issued regarding bonus depreciation.

The Economic Stimulus Act of 2008 provided a significant tax incentive for businesses to make capital investments by adding a special 50 percent depreciation allowance for qualifying purchases. This special “bonus depreciation” allowance is available to all businesses and applies to most types of tangible personal property and computer software acquired and placed in service in 2008. It allows taxpayers to deduct 50 percent of the cost of qualifying property in addition to the regular depreciation allowance that is normally available.

As part of the Department’s continuing efforts to help taxpayers take advantage of the business provisions included in the Economic Stimulus Act of 2008, the Treasury Department and IRS are also preparing additional guidance to address a number of issues that have been identified. Taxpayers are encouraged to bring issues to the attention of the IRS that may require expedited guidance to ensure that taxpayers are able to fully realize the benefits of these incentives. Please contact us for further support and guidance.

The upcoming guidance will also cover the new increased limits that businesses can expense under the Economic Stimulus Act of 2008. Generally, the new law set a limit of $250,000 that a business can expense during 2008, up from the limit previously set for 2008 of $128,000.

A detailed description of the business provisions contained in the Economic Stimulus Act of 2008 is available in IRS Publication 553, Highlights of 2007 Tax Changes.

Education tax credits can help offset the costs of higher education for yourself or a dependent. The Hope Credit and the Lifetime Learning Credit are two education credits available which may benefit you. You may be able to subtract them in full from your federal income tax, rather than just deducting from your taxable income.

The Hope Credit

• Applies only for the first two years of post-secondary education, such as college or vocational school. It does not apply to graduate and professional-level programs.
• It can be worth up to $1,800 per eligible student in 2008.
• You're allowed 100% of the first $1,200 of qualified tuition and related fees paid during the tax year, plus 50% of the next $1,200.
• Each student must be enrolled at least half-time for at least one academic period which began during the year.

The Lifetime Learning Credit

• Applies to undergraduate, graduate and professional degree courses, including instruction to acquire or improve job skills.
• If you qualify, your credit equals 20% of the first $10,000 of post-secondary tuition and fees you pay during the year, for a maximum credit of $2,000 per tax return.

You cannot claim both the Hope and Lifetime Learning Credits for the same student in the same year.

To qualify for either credit, you must pay post-secondary tuition and fees for yourself, your spouse or your dependent. The credit may be claimed by the parent or the student, but not by both. Students who are claimed as a dependent cannot claim the credit.

These credits are phased out for Modified Adjusted Gross Income over $48,000 ($96,000 for married filing jointly) and eliminated completely for Modified AGI of $58,000 or more ($116,000 for married filing jointly). If the taxpayer is married, the credit may be claimed only on a joint return.

Call us for more information, or see IRS Publication 970, Tax Benefits for Education.

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