Employee vs. Independent Contractor:
The IRS is looking closer at companies who pay Independent Contractor and they are challenging the independent contractor status. This is an easy way to raise a lot of money for the US Treasury.
A worker performing services for a business falls under one of the following classifications:
- An independent contractor.
- A common-law employee.
- A statutory employee.
- A statutory non-employee.
Questionable employment tax program (QETP).
When the IRS determines that a worker is actually an employee rather than an independent contractor, the employer is subject to penalties for failure to withhold income, FICA, and Medicare tax. Penalties and interest also apply for failure to pay FUTA, as well as penalties for failure to file information returns.
The IRS has initiated a new program for 2008 to address employers who intentionally misclassify employees to avoid federal and state employment taxes. The QETP helps the IRS and state tax authorities to share information with each other.
QETP is also designed to educate employers on their employment tax responsibilities.
A self-employed worker who is generally responsible for paying his or her own taxes through estimated tax payments. The business hiring the worker issues a 1099-MISC for payments of $600 or more, but generally is not responsible for withholding income tax or FICA.
A worker treated as an employee under common factors that indicate employee status (Rev. Rul. 87-41). The business hiring the employee issues Form W-2 for wages paid and is responsible for withholding income tax and FICA. The employer is also liable for FUTA and various state employment taxes. The employee may also be eligible for fringe benefits offered by the employer.
Any officer of a corporation providing services for his or her corporation in exchange for compensation is an employee of the corporation. [IRC §3121(d)(1)]
A director of a corporation in his or her capacity as such is not an employee of the corporation. [Reg. §31.3121(d)-1(b)]
A worker who may qualify as an independent contractor under the common-law rules, but is treated as an employee under the IRC [IRC §3121(d)(3)]. See Statutory employees, page 5-9, for a list of workers classified as statutory employees and for rules on how to report their income and expenses.
A worker who could be considered a common-law employee, except that the IRC treats him or her as being self-employed (IRC §3508). There are three categories of statutory non-employees:
- Direct sellers – Person who falls under one of the following:
- Sells consumer products to consumers outside of a permanent retail store.
- Sells consumer products to buyers on a buy-sell basis or a deposit-commission basis outside of a permanent retail store.
- Delivers or distributes newspapers or shopping news.
- Licensed Real Estate Agents
Both of the above are treated as self-employed if:
– Substantially all payments for services performed are directly related to sales or other output, rather than to the number of hours worked, and
– Services are performed under a written contract that states they will not be treated as employees for federal tax purposes.
- Companion sitters person. A companion sitters person is an individual who provides personal attendance, companionship, or household care to children or to individuals who are elderly or disabled, and are not employees of a companion sitting service.
Factors Used to Determine Independent Contractor vs. Common-Law Employee Status Except for specific types of work mentioned under statutory employees and statutory non-employees, the general rule is a worker is an independent contractor if the business that hires the worker has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
In contrast, a worker is a common-law employee if the business that hires the worker has the right to control what will be done and how it will be done. The key factor centers on who has the right to control the details of how the services are to be performed.
Revenue Ruling 87-41 Lists 20 Factors used to determine if a worker is an independent contractor or a common-law employee. IRS Pub. 15-A divides these factors up into three categories:
- Behavioral control.
- Financial control.
- Type of relationship between worker and the business that hires the worker.
Factors that indicate a business has the right to control a worker’s behavior include:
- Instructions that the business gives to the worker. Employers generally control when and where work is to be done, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, and what order or sequence to follow.
- Training that the business gives to the worker.
- Employees may be trained to perform a service in a particular manner.
- Independent contractors generally use their own methods.
Factors that indicate a business has the right to control the business aspects of a worker’s job include:
- Extent a worker has unreimbursed business expenses. Independent contractors are more likely to incur expenses that are not reimbursed, such as fixed overhead costs that the worker incurs regardless of whether work is currently being performed.
- Extent of a worker’s investment. Independent contractors often have significant investment in facilities used to perform services for someone else, such as maintaining a separate office or other business location.
- Extent to which the worker makes his or her services available to the public. Independent contractors are generally free to offer their services to other businesses or consumers. They often advertise and maintain a visible business location.
- Method of payment for services performed. Employees generally are guaranteed a regular wage and work for an hourly fee or a salary. Independent contractors are generally paid a flat fee for a specific job. Exceptions apply to some professions, such as accountants and lawyers who charge hourly fees for their services.
- Extent to which the worker can make a profit. Independent contractors can make a profit or a loss.
Type of Relationship
Factors that indicate the type of relationship include:
- Written contracts that describe the relationship and intent between the worker and the business hiring the worker.
- Employee-type benefits provided to worker. Employers often provide fringe benefits to employees, such as health insurance, pensions, and vacation pay.
- Permanency of the relationship. Employer-employee relationships generally continue indefinitely.
- Extent services performed by the worker are a key aspect of the business hiring the worker. A worker who is key to the success of a business is more likely to be controlled by the business, which indicates employee status.
For example, an attorney firm hires an attorney to provide legal services for clients.