IRS Clarifies "Employee" Versus "Independent Contractor" Test
The IRS recently issued clarifying guidelines to help employers determine which workers should be treated as independent contractors or employees. The government naturally wants accurate decisions to be made since they determine when it’s paid certain taxes on each worker’s wages.
The main deductions that should be subtracted from all employees’ paychecks include those for Social Security, Medicare, unemployment and income taxes. When a business has work done by an independent contractor, that person must pay all those taxes in the form of self-employment tax.
What remains the general standard for deciding if a worker is an independent contractor?
If an employer reserves the right to only direct control over the result of the work – and cannot tell a worker exactly what to do and how to handle the assignment – then that worker will usually be legally viewed as an independent contractor.
However, deciding what constitutes specific directions for completing a given task can still fall into a gray area.
Fortunately, there are three basic analytic categories that can help employers accurately determine when workers are properly classified as “employees” or “independent contractors.”
What are the three main categories of analysis for deciding a worker’s correct status?
The IRS indicates that employers should carefully examine the following three aspects of how they relate to workers to determine their proper work status.
Behavior control. An employer may have behavior control over a worker even when it does not exercise it. For example, when such control is involved, it may include telling a worker which specific tools to use and where those supplies should be purchased. Under those circumstances, the worker should be considered an employee. Conversely, the less control over a worker’s behavior, the greater the chance that the person is working as an independent contractor.
If there are strict guidelines for determining the quality of the work provided, there’s a strong chance that the worker is an employee. When the worker is provided a bit more leeway in terms of quality control – there’s a stronger chance that the person is an independent contractor.
Of course, the two parties will usually need to agree to some basic quality standards, regardless of whether the worker is an employee or independent contractor. Finally, if periodic training or ongoing training is required of a worker – that increases the chances that the worker should be treated as an employee.
Financial control. Does the worker have to personally cover the majority (or all) of the expenses tied to completing the work? These might include the purchase and maintenance of proper computers, printers, fax machines, scanners and other required equipment. If the worker is covering all those expenses, he or she should probably be classified as an independent contractor.
Stated differently, when a worker has many unreimbursed expenses, that person is usually an independent contractor -- not an employee. Independent contractors are also those who retain the right to continue obtaining additional work from other parties. As for the payment for services, independent contractors are usually paid a flat fee – although that arrangement can vary in some cases.
How the employer and worker each perceive the nature of their relationship. When the parties have not negotiated any employee benefits like vacation pay, sick pay, a pension plan and stock options – the worker is usually an independent contractor. While a written contract signed by the two parties can indicate how they view their interactions, it’s not always the only evidence the IRS and the courts will review when classifying the work relationship. All relevant documents and communications may need to be examined.
The main consequence for an employer who misclassifies a worker is that the employer may be required to pay all employment taxes currently owing for that worker – as opposed to requiring the worker to cover them.
What unique emphasis is placed on these three categories in the updated guidelines?
As for behavior control, employers really shouldn’t be telling the independent contractor the exact sequence of events for all tasks to be performed or exactly how they should be handled.
Regarding financial control, only independent contractors can experience a profit or loss while handling assigned tasks. Employees whose expenses are generally covered will usually not experience any profit or loss while completing assigned tasks on a given schedule.
As for how the parties view their work relationship, a fully executed contract can be controlling when other conclusive details aren’t available. However, as briefly noted above, the parties’ communications can usually provide clear indications of whether they’re interacting as employer-employee or employer and independent contractor.
The key bottom line for employers who don’t want to only work with employees – is to allow their independent contractors considerable flexibility while completing tasks – while respecting professional standards acceptable to both parties.
Please give our law firm a call if you need any help determining which workers are employees or independent contractors. We can also help you better understand the many different types of classifications that govern a wide range of employees you may want to hire – and the tax consequences for hiring those who fit in each group.
Our firm always remains available to help you draft many different types of contracts that can serve all your business needs.