17 Worker Classification

Many employers take advantage of low-income workers by treating them as independent contractors rather than employees.1  Employers do not figure or withhold taxes from payments to independent contractors. This includes the Social Security and Medicare taxes that are automatically deducted from W-2 wages as employment taxes (i.e., FICA). Instead, the worker must figure and pay income and employment taxes by filing and paying quarterly estimated taxes to the IRS. An individual can use IRS form 1040-ES to figure and pay estimated taxes. Many workers do not know or understand how to do this, and they are surprised when they have a large tax bill when they file their return.

A taxpayer can file a Form SS-8 with the IRS to get a determination as to whether the taxpayer is an employee or independent contractor.2  If the determination is that the taxpayer was misclassified as an independent contractor and is really an employee, the taxpayer won’t have to pay the employment taxes.

Form 4852 can be used to report employment income and pay payroll taxes if the employer won’t issue a Form W-2. After the worker pays the payroll taxes, the worker should file for a correction of wage earnings with the Social Security Administration.3  This should be done promptly since there is a time limit for correcting earnings records.4

An employee has a cause of action in tort against an employer who fails to correct inaccurate information provided to the IRS.5  If the employer fraudulently filed the information return, I.R.C. § 7434 gives the employee has a private cause of action for actual damages or statutory damages of $5,000, whichever is greater.

A taxpayer who really is an independent contractor should keep careful records of business income and expenses and use a Schedule C to report any business expenses and thereby lower the amount of taxable income. Documentation of these expenses, such as cancelled checks, receipts, or business account statements, should be kept for at least 3 years in case the IRS decides to examine the return.

Many workers in the “gig economy” such as delivery persons and rideshare drivers for Uber or Lyft are treated as independent contractors whose income is reported to the IRS by the third party arranging the work. The IRS refers these companies as Third Party Settlement Organizations (TPSOs). Historically, a TPSO did not have to report payments to a worker if the payments did not exceed $20,000. As a result of the American Rescue Act of 2021, TPSOs must now report all payments that exceed $600. Obviously, substantially more income will be reported due to this change, and many gig workers may be responsible for paying taxes on income that had previously gone unreported to the IRS. TPSOs’ reporting is done by Form 1099-K.

• 1For addition discussion of misclassification, see Section 3 of the chapter on Employment Law.
• 2For a detailed discussion of the tests for employee status, see Effectively Representing Your Client Before the IRS ch. 20 (8th ed. 2021).
• 3See 20 C.F.R. § 404.801, et seq.
• 420 C.F.R. § 404.802.
• 5See, e.g., Clemens v. USV Pharm., 838 F.2d 1389, 1395 (5th Cir. 1988) (tort action under Louisiana law).