Where’s the line?
When an employer hires workers an important question is whether the compensation they receive is subject to employment taxes. The answer depends on whether the worker is an employee or an independent contractor. This determination of the worker’s status depends on certain facts . . . facts which define the type and terms of the business relationship that exists between the parties at the time the services are rendered.
In this brief article I hope to provide an overview of the issue and provide a link to a more in depth report. I teamed up with Robert Long (a frequent contributor to this blog) of Coral Springs, Florida to make sure I provided accurate information. Robert is a CPA with his own practice (Robert E. Long MA, CPA, PA) and has been serving small businesses for decades. As the internet and email has made our world more virtual, Robert now serves small business owners in many states across the nation. Be sure to click the link at the bottom for his full report. Here are some of his thoughts on the subject.
Workers who are classified as employees, sometimes referred to as a “common law employees”, are hired by an organization to perform specific work under the direction of the employer. In contrast, workers who are classified as independent contractors are in business for themselves and they perform work for an organization without direction from the party who pays for their services.
Employment taxes apply solely to the remuneration paid to workers classified as employees. The distinction between employees and independent contractors is important because employers must deduct certain taxes from employee’s checks. For example, employers are obligated to deduct Federal income tax withholding, “match” Social Security and Medicare taxes, and to pay Federal unemployment taxes for their employees. Employers may also be obligated to pay for state income taxes. In addition, the employer or employee may have to pay state unemployment compensation contributions and state disability insurance. Employers are not typically required to pay these taxes if they employ independent contractors.
If an individual is working as an independent contractor, the “employer” does not make any Social Security/Medicare deductions. The independent contractor must pay his or her own “self-employment taxes” along with income tax on earnings.
A common problem arises when, perhaps years later, the IRS, Department of Labor or state taxing authorities classifies the independent contractor as an employee, leading to retroactive overtime pay, retirement benefits and medical claims for job-related injuries. In these cases, the independent contractor’s job-related expense write-offs may be disallowed or subject to the 2% of Adjusted Gross Income rule on the 1040 which can create issues with how the independent contractor’s past tax returns have been filed as well as any taxes paid or refunded.. These issues may not arise until after a substantial period of time has passed.
To avoid this situation, the employer or the independent contractor can make a request to the IRS to seek determination on whether a worker is an employee. The only requirement for this determination is to have filed a detailed Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding).
The Internal Revenue Provides Some Guidance
When determining whether an individual is an employee or an independent contractor, the IRS stresses that ALL evidence of the degree of control and degree of independence must be considered. The current I.R.S. official guidance, in Publication 15-A, Employer’s Supplemental Tax Guide – Supplement to Circular E, indicates that facts which provide evidence of the degree of control and independence fall into three major categories: behavioral control, financial control, and the type of relationship between the parties, as follows:
I.) Behavioral Control Facts indicate whether the business has the right to direct and control how the worker performs the task for which the worker has been hired. Behavioral control includes instructions and training that the business gives to the worker.
II.) Financial Control Facts indicate whether the business has a right to control the business aspects of the worker’s job. Financial control includes the extent to which the worker has unreimbursed business expenses, the extent of the worker’s investment to perform the services, the extent to which the worker makes services available to other businesses, how regularly the business pays the worker, and the extent to which the worker is able to make a profit or incur a loss.
III.) Type of Relationship Facts indicate the type of relationship that exist between the parties include written contracts describing the type of relationship the parties intended to create, whether the business provides the worker with employee-type benefits such as insurance, a pension plan, vacation pay, or sick pay, the permanency of the relationship, and the extent to which services performed by the worker are a key aspect of the regular business of the company.
Employers can avoid the high cost and inconvenience of having their workers’ classifications changed from independent contractors to employees by vigorously applying 20 common-law factors.
NOTE: For the full report, details on the 20 common-law factors and a list of great resources, click here.
This explanation is distributed with the understanding that we are not rendering legal, accounting or other professional services or advice. If such advice or assistance s required, an attorney or accountant should be consulted.
Hopefully, this short article has given you enough information to pique your interest in downloading the full report (link above) to reduce the amount of legal risk to which you expose your company. If you would like to contact Robert Long, you can do so by calling him at 954-603-0480, emailing him at rlong33424@aol.com or through his LinkedIn page.
If you would like to contact me, you can do so by emailing me at mike.clough@bestbizpractices.org or visiting my LinkedIn page.
Posted by: Mike Clough
