How To Be Eligible For Independent Contractor Tax Status

August 17, 2019 | By: Robert A. Green, CPA | Read it on

There are significant tax advantages for independent contractors (IC) vs. employees.

  • ICs deduct business expenses, whereas, the new tax law (TCJA) suspended “unreimbursed employee business expenses” as miscellaneous itemized deductions.
  • ICs are eligible for TCJA’s 20% qualified business income (QBI) deduction, whereas, employees are not.
  • ICs owe 100% of social security and Medicare taxes (SE tax) on net business income, whereas employers and employees share social security and Medicare taxes 50/50 on salaries.
  • ICs are not enrolled in employer health insurance and retirement plans, whereas employees are. ICs can have individual health insurance and retirement plan AGI-deductions.

You cannot make this determination of IC vs. employee status based on your preference alone. Learn the IRS rules on worker classification. (See IRS resources and Client Letters below.)

Current developments
Some “self-employed individuals” (SEI) hire “professional employer organizations” (PEOs), known as employee leasing companies, to join the PEO payroll and employee benefit plans. The SEI reimburses the PEO for these employment costs, plus a fee. The IRS recently balked at this practice for SEIs.

IRS Chief Counsel Advice (CCA) 201916004 dated April 19, 2019, stated that PEOs could not treat SEIs as employees. PEOs should issue SEIs a Form 1099-MISC for non-employee compensation; not a W-2. This reclassification precludes the SEI from participation in a PEO employee benefit plan. The IRS does not permit sole proprietors, and partners to pay themselves wages. A partnership reports “guaranteed payments” to partners.

Trading income is unearned income. TTS traders use an S-Corp to have officer compensation for arranging employee benefits, including health insurance and retirement plans.

The IRS recently released draft 2020 Form 1099-NEC (non-employee compensation). For the 2019 tax year, a business should continue to report non-employee compensation on Form 1099-MISC box 7. The 2020 Form 1099-NEC will give the IRS more capability to track non-employee compensation. I expect the IRS to examine more companies and challenge their worker classification. Get on the right side of this issue now.

IRS Independent Contractor (Self-Employed) or Employee?
Understanding Employee vs. Contractor Designation

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Darren Neuschwander CPA contributed to this blog post.