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Each year in the United States vast amounts of income are not reported to the Internal Revenue Service. Estimates indicate unreported payments for child care alone total $11 billion annually. It is widely acknowledged much of the labor in this so-called underground economy is provided by undocumented aliens. Although this issue usually gets little publicity, it became almost a national obsession earlier this year when it was found Zoe Baird, a nominee for U.S. attorney general, had illegally hired a Peruvian couple to perform household and baby-sitting duties. To make matters worse, she paid their Social Security taxes only after she learned she was being considered for a cabinet post. One possible reason for Ms. Baird's problems is that two complex and little-publicized aspects of the law--payroll taxes and immigration --were involved.
PAYROLL TAXES
Many taxpayers, both individuals and businesses, have their first contact with the underground economy when they hire someone who does not report income to the IRS. Employers (who can be individuals or businesses) must withhold two types of federal payroll taxes from employees' wages: federal income taxes and Federal Insurance Contributions Act (FICA) taxes. Most employers also are liable themselves for two types of federal payroll taxes: Federal Unemployment Tax Act (FUTA) taxes and FICA taxes equal to the employees' FICA taxes. However, the withholding requirements and payroll taxes are not applicable if the service provider is considered to be an independent contractor. For the withholding rules and payroll taxes to apply, there must be an "employer-employee" relationship between the worker and the service purchaser.
EMPLOYER-EMPLOYEE RELATIONSHIP. For most taxpayers the existence of an employer-employee relationship depends primarily on the control the service purchaser retains over the manner in which the services are performed. In general, if the service purchaser has the right to control the details and means by which services are performed, an employer-employee relationship most likely exists. Unfortunately, there are few hard and fast rules. Every factor of each individual situation must be evaluated to make a reliable determination. To help taxpayers do this, the IRS has enumerated 20 factors it uses to distinguish employer-employee from other work relationships. Some of the more common factors are listed in exhibit 1, page 40. (Exhibit 1 omitted)
These factors are...