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Yes, he can. It is not up to you or your employer to decide if you are treated as employee (taxes withheld) or independent contractor (no taxes withheld). The rules are set by the IRS. If the employer realized that you should have been treated as employee from the beginning and just trying to correct his mistake, he is allowed to do so. Your employer can ask you to refund the overpayment or just take it out of your next paycheck.
If he paid you, you worked for him, hired or not. Again, it is not up to you to decide if you are contractor or employee. There are rules the employer must follow. If he classify those 6 weeks (5/20 - 6/30) as training, he pays you as employee, not as contractor. Per IRS he is not allowed to pay you as contractor for training time.
The fact that he doesn't use professional payroll system just play into his cards. He admits that he made a mistake and he was only trying to fix it.
Contractors typically do not receive training by the hiring firm. They use their own methods to accomplish the work.
Here are some rules that determine how a workers is classified:
Notice the Internal Revenue Service Twenty Factor Test
If somebody pays you for a services you performed, you are contractor or employee. There's nothing in between. If you are not an employee, you are contractor. Volunteers don't get paid for work they perform. The employer must classify you somehow and he cannot classify you as volunteer. If the employer provides the tools, supplies and training, set expectations where and how the work is done, he has employees, not contractors.
Unless you are truly self-employed, it is for your own benefit to be classified as employee, not contractor. If your employers report the payment as nonemployee compensation, you will have to pay 15.3% self-employment tax (social security and Medicare tax) in addition to income tax. As employee, you only pay half of it. It is much easier and much cheaper for an employer to classify workers as contractor. Your employer must have a good reason why he classify you as employee starting May 20. Most likely after consulting a tax professional or accountant he is trying to do it right.
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There are two ways to account for reimbursement: accountable plan and nonaccountable plan.
Under accountable plan you submit an expense report and the employer reimburse you only for what on your report or for what you have receipts. Under this method, the reimbursement is not included in your taxable income and you cannot deduct the expenses on your tax return.
Under nonaccountable plan, your employer pays your certain amount every week/month or lump sum and doesn't require any mileage log, expense reports or receipts. Under this method, the amount is included in your taxable income and you can deduct the actual expenses on your tax return.
If the reimbursement is included on your paycheck, you can deduct the actual expenses as employee business expenses on your tax return.
The reimbursement is just like any compensation or payment. He can pay you the $50 reimbursement and than tell you that you owe him $50, it comes to the same thing.
When an employer overpays you (because of his or your mistake), he can use any funds due to you (wages, reimbursement, vacation pay, sick days) to apply towards the overpayment. Some employers keep it separate, some employers just take whatever they owe you. If you owe him money and he can use any means available to him to get it back.
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