Blog

If you’re one of the many businesses that use independent contractors to help keep down costs, you’ll want to ensure that these workers are classified properly for federal tax purposes. It can be a costly mistake if the IRS reclassifies them as employees.

Determining whether a worker is an employee or an independent contractor for the purposes of federal income and employment tax can be complex. If a worker is an independent contractor, businesses must simply send the contractor a Form 1099-NEC for the year showing the amount paid if the amount is $600 or more.

However, if the worker is an employee, the company must withhold federal income and payroll taxes as well as pay the employer’s share of FICA taxes on the wages—in addition to FUTA tax. There may also be state tax obligations, and the business may provide the worker with fringe benefits that it makes available to other employees. 

Factors considered by the IRS

Unfortunately, there isn’t a uniform definition for the term “employee”. 

Generally speaking, if the organization an individual works for has the right to direct and control them in the jobs they’re performing, the IRS and courts have typically ruled that the individual is an employee. Otherwise, an individual is generally classified as an independent contractor. However, other factors—such as who pays expenses and who provides tools—are also taken into account.

Under Section 530, employers may get some relief from employment tax liabilities if they’ve misclassified workers as independent contractors. However, the employer must also meet certain requirements, such as treating all similarly situated workers as contractors and filing all federal returns in a way that’s consistent with its treatment of a worker as a contractor.

It’s also worth noting that section 530 doesn’t apply to certain types of workers.

Form SS-8 and allowing the IRS to decide

It’s possible to ask the IRS to rule on whether a worker is an employee or independent contractor by filing Form SS-8. However, the IRS historically has tended to classify workers as employees rather than independent contractors.

Before you file Form SS-8, you should first consult with us. Filing Form SS-8 could unintentionally trigger an employment tax audit by signalling to the IRS that your business has worker classification issues.

It’s often better to focus on properly treating workers as independent contractors so that their employment status complies with the tax rules.

Form SS-8 can also be filed by workers who want the IRS to officially determine their status. Independent contractors who are disgruntled because they feel entitled to employee benefits or who want to avoid self-employment tax liabilities may file a Form SS-8.

If a worker does so, the IRS notifies the business by mail in a letter. This letter will identify the worker and include a blank Form SS-8. The IRS will request that the business complete and return the form, and it will then render a classification decision.

Although this covers the basic tax rules, there are always new developments. The U.S. Labor Department recently withdrew a non-tax rule that was introduced under the Trump administration and made classifying workers as independent contractors easier. If you have questions about how to classify workers at your business, contact us. We can help you ensure that your workers are classified properly.

In recent years, accounting rules have changed, and certain balance sheet items—such as asset retirement obligations, derivatives, and intangible assets acquired in a business combination—must now be reported at “fair value” rather than historical cost. Reporting at fair value brings your company’s financial statements into better alignment with today’s market values, but estimating fair value can require subjective judgment.

What is fair value?

Fair value is defined under U.S. Generally Accepted Accounting Principles (GAAP) as “the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.” Available, quantifiable market-based data should be used to estimate the fair value of assets and liabilities according to Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures.

Topic 820 classifies valuation inputs under a three-tier valuation hierarchy:

1. Quoted prices for identical assets or liabilities in active markets
2. Any information derived from publicly quoted prices, such as prices of comparable stocks and older prices from inactive markets
3. Management’s estimates and nonpublic information 

Measurements of fair value may require a high degree of subjectivity, especially when based on the third level of inputs, and this can make them susceptible to misstatement. As such, these estimates usually require more focus from auditors.

Approaches for making fair value estimates

Under current auditing standards, auditors are generally required to select one (or a combination of) these approaches in order to substantively test their fair value measurements:

• Developing an independent estimate. Auditors come up with an estimate using management’s assumptions (or alternate assumptions). This estimate is then compared to what’s reported on the internally prepared financial statements.
• Reviewing subsequent events or transactions. Events or transactions that occur after the balance sheet date but before the date of the auditor’s report are used to gauge the reasonableness of fair value estimates.
• Testing management’s process. The reasonableness and consistency of management’s assumptions is evaluated by auditors, who also test to ensure that the underlying data is complete, accurate and relevant.

Contact us today

Measuring fair value may be outside the comfort zone of your in-house accounting personnel—but an outside valuation expert can support the fair value of assets and liabilities with objective, market-based evidence. For more information, contact us today.