How to be eligible for the tax status of independent entrepreneur
There are significant tax advantages for independent contractors (ICs) over employees.
- The CI deduct business expenses, while the new tax law (TCJA) suspended “employee unreimbursed business expenses” as miscellaneous itemized deductions.
- CIs are eligible for the 20% qualifying business income (QBI) deduction of the TCJA, while employees are not.
- CIs owe 100% of social security and health insurance taxes (SE tax) on net business income, while employers and employees share social security and health insurance taxes at 50 / 50 on wages.
- CIs are not enrolled in the employer’s health and pension plans, while employees are. CIs can benefit from AGI deductions for individual health insurance and pension plan.
You cannot determine IC status versus employee status based solely on your preferences. Learn the IRS rules for classifying workers. (See IRS resources and client letters below.)
Some “self-employed” (SEI) hire “professional employers’ organizations” (PEOs), called employee leasing companies, to join PEO’s pay and benefit plans. UTE reimburses PEO for these salary costs plus a commission. The IRS recently abandoned this practice for UTEs.
IRS Chief Legal Counsel (CCA) 201916004 dated April 19, 2019, stated that PEOs cannot treat UTEs as employees. PEOs must issue UTEs a Form 1099-MISC for non-employee compensation; not a W-2. This reclassification prevents SEI from participating in a PEO employee benefit plan. The IRS does not allow sole proprietors and partners to pay each other wages. A partnership declares “guaranteed payments” to partners.
Business income is unearned income. TTS traders use an S-Corp to obtain executive compensation to organize employee benefits, including health insurance and pension plans.
The IRS recently released a draft Form 2020 1099-NEC (compensation of non-employees). For the 2019 tax year, a business must continue to report compensation for non-employees on Form 1099-MISC box 7. Form 2020 1099-NEC will give the IRS more capacity to track compensation for non-employees. -employees. I expect the IRS to look at more companies and question their classification of workers. Get on the safe side of this question now.
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Darren Neuschwander CPA contributed to this blog post.