Penalty Contractor Vs. Employee
Proper classification of workers as employees or independent contractors can be a tough issue for many employers, but is an extremely important one. The Internal Revenue Service (IRS) severely penalizes employers who misclassify workers.
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If 1099s Were Not Filed
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If you treated the worker as an independent contractor but did not file 1099s, the IRS can levy severe penalties against you, including a 3 percent penalty for failure to withhold income tax. You would also owe the full employer portion of Social Security and Medicare taxes plus 40 percent of the employee's portion, which comes to 8.68 percent for Social Security and 2.03 percent for Medicare.
If 1099s Were Filed
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If you filed 1099s for the worker, the IRS cuts the penalties in half. In this case, you would owe a 1.5 percent penalty for failure to withhold income tax. You would still owe the full employer portion of Social Security and Medicare taxes, but only 20 percent of the employee portion, for a total of 7.44 percent for Social Security tax and 1.74 percent for Medicare tax.
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Section 530 Relief
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You may also apply for Section 530 Relief, which would exempt you from any penalties. To be considered for relief, you must have a "reasonable basis" for your treatment of the worker, filed all returns consistent with your treatment of the worker and never have treated a worker performing similar duties as an employee.
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