Avoid tax mistakes when classifying farm employees

See related article: Extension helps bust tax myths

In this two-part series, tax professionals partnering with USDA debunk common misconceptions about taxes and USDA programs. This week focuses on farm employees and mistakes for employers to avoid when filing taxes.

Kevin Burkett is an Extension associate at Clemson University working in farm management and taxation, providing tax and farm management education. This includes work with producers, tax professionals, students and others in agribusiness.

Myth No. 1:  Choosing to pay employee as independent contractor

It is important that business owners understand rules and implications for independent contractors versus employees.

In agriculture, there is often a cyclical and seasonal nature that results in unique working relationships. Sometimes a business may inadvertently treat someone as an independent contractor when they should be classified as an employee.

There are specific rules for determining the type of relationship that exists. It always depends on the facts and circumstances of a particular scenario. The common law examines the behavioral control, financial control, and the overall relationship of the two parties, in this Internal Revenue Service document.

The “economic reality” examines if the worker is financially dependent on the decisions of the business or if they operate in an independent nature, separate from the farming business.

Generally, a business would prefer a worker to be an independent contractor, and the worker would like to be classified as an employee. This can further muddy the issue. Overall, there can be significant tax and legal consequences when a worker is not properly classified as an employee.

Numerous resources are available through the Internal Revenue Service (IRS) such as: this IRS discussion page, IRS Publication 1779, and IRS Publication 15-A.

It is not always clear how a relationship should be defined.

For a brief analysis:

• An employee performs services for a business where an employer has control over what will be done and how it will be done.
• An independent contractor self-directs what they will do and how they will do it. A payer for those services only has control in the result of the work.

An independent contractor is typically engaged for shorter-term, project-based work that results in them receiving one or several lump-sum payments. Assuming the payments are greater than $600 for their services, a 1099 will be issued from the business to both the worker and the IRS. (Even if a 1099 is not required to be issued, these payments should still be properly recorded by the worker and the business).

An employee is a more indefinite relationship, and the engaging business directs and oversees the worker. This is a greater relationship than a project-based and arm’s length arrangement. The worker receives a W-2 from the employer and could be entitled to other benefits from the employer such as insurance, work leave, minimum wage, etc.

If no conclusion can be reached in regard to the relationship, a request can be sent to the IRS via Form SS-8. The IRS will review the circumstances of the scenario and make a determination.

Myth No. 2: Misclassifying employees is OK

For tax purposes, a business that misclassifies an employee as a contractor can be subject to $50 per unfiled W-2, 1.5% or 3% penalty on the wages, 20% or 40% for employment taxes for the employee, and 100% for employment taxes for the employer portion. These can be substantial amounts for the employer. If the employer is found to “intentionally disregard” the law, they can be fully liable for income taxes that should have been withheld. There will likely be state tax consequences as well.

Additionally, there can be other legal and social consequences the business must deal with. This could range from a bad reputation for the employer, to significant fines, bans, lawsuits or even jail time, depending on the severity. For this reason, tax preparers, employers, workers, and other business consultants should be aware of the current rules and how to navigate them appropriately.

More information about taxes and USDA programs is available on the Taxes and USDA Programs webpage.