IRS Worker classification and Employment Taxes

By | December 5, 2015

Worker classification does seem to be a recurring employment tax issue. We’ll provide an overview of the issue. Workers may be classified as either independent contractors or employees. An independent contractor is different from an employee, both in definition and tax responsibility. If a worker is an employee, the business will have to meet all of the withholding requirements, file the proper employment tax returns, and furnish a W-2 wage and earnings statement to the employee. Generally, if the worker is an independent contractor and the business pays $600 or more to the worker during a calendar year, the business must issue a Form 1099-Miscellaneous to the worker.


Backup Withholding Responsibilities

The business should also be aware that they may have backup withholding responsibilities if they fail to secure a valid taxpayer identification number, or TIN, from the worker. On the next two slides are copies of Forms W-2 issued to employees and 1099-Miscellaneous issued to independent contractors. Form W-2, which is used to report wages to employees, Form 1099- Miscellaneous is used to report income to independent contractors.


How to make a determination as to who is an employee and who is an independent contractor?

Contractors and subcontractors, for example, who follow an independent trade, business, or profession in which they offer their services to the public are generally not employees. However, whether such people are employees or independent contractors depends on the facts and circumstances of each case. The right to direct and control the workers really is key in determining the proper worker classification, and evidence falls into three categories: Behavioral control: does the company control or have the right to control what the worker does and how the worker does his or her job? Financial control: are the business aspects of the worker’s job controlled by the payer? This would include criteria like how the worker is paid, whether the expenses are reimbursed, and who provides tools and supplies. Relationship of the parties: are there written contracts or employee benefits, including for example fringe benefits, insurance, or vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?


Factors to Determine Employee of Independent Contractor

There is quite a lot we can say about behavioral control. The key issues for behavioral control are instructions and training. Types of instructions includes things like how, when, where to do the work, 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, what order or sequence to follow when performing the work. Degree of instruction means that the more detailed the instruction, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflect less control, indicating that the worker is more likely an independent contractor.


What are some of the other factors in determining whether the worker is an employee versus independent contractor?

The next factor is training. Training means explaining detailed methods and procedures to be used in performing a task. If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is solid evidence that the worker is an employee. Periodic or ongoing training about procedures and methods is even stronger evidence of an employee/employee relationship. However, if a former employee who had terminated employment is rehired by the company to perform substantially similar duties, training would not typically be required. Therefore, training or the lack of training in this circumstance is not indicative of the worker being an independent contractor.


Controlling Independent Contractors

When looking at behavioral control, the key fact to consider is whether the business retains the right to control the worker and the details of how the services are performed, regardless of whether the business actually exercises that right. Here’s an example. An electrician agrees to install wiring in a new warehouse under construction. Upon arriving at the warehouse, the electrician is given the building plans showing where the wiring is to be installed and advised that the wiring must be completed within five days. In this example, the directives concern what is to be done rather than how it is to be done, and is consistent with independent contractor status. Here’s another example, which points more to the worker being an employee. An electrician works for a general contractor. The warehouse owner hires the general contractor and the general contractor tells the electrician what wiring has to be done, gives specific instructions on installation regarding the wiring, provides the tools to use, and dictates the order in which the wiring is to be installed. In this example, these are specific instructions on how the work is to be performed. This is consistent with employee status.

Financial Control of Employees

The second category is financial control. Financial control refers to whether the business has the right to control the financial aspects of the worker’s job. Let’s talk about several different ways a business exercises financial control. First, there’s investment. An independent contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many occupational industries, such as construction, workers spend hundreds of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, a significant investment is not necessary for independent contractor status, as some types of work simply do not require large expenditures. Next are expenses. Employers are more likely to reimburse employees for their job expenses, while businesses usually do not reimburse independent contractors for expenses. However, employees may also incur expenses that are not reimbursed.

A school teacher is an employee. She buys erasers, posters, and other minor supplies throughout the year, and she is not reimbursed for these expenses. Minor expenses incurred by an employee are not indicative of an independent contractor relationship. The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used, and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money; that is to say, their expenses will exceed their income from the work. For example, the electrician we mentioned a moment ago, might agree to wire a warehouse for a set price. That electrician stands to make a profit or bear a loss depending on the electrician’s skill in bidding the job. Having the possibility of incurring a loss or turning a profit indicates that the worker is an independent contractor. Another indication of financial control would be who provides the insurance coverage, including workers compensation insurance.

If a worker covers their own insurance, the relationship is probably that of an independent contractor. If the business provides the insurance coverage, the relationship would more likely be an employee relationship. A final point here concerning profit and loss is that you should consider who is responsible for correcting a mistake on the job. If the business is responsible for correcting and paying for the mistake, the relationship is probably an employee relationship. If the worker is responsible for correcting and paying for the costs to rectify an error or mistake, the worker is more likely to be an independent contractor. While we’re talking about the category of financial control, we also want to consider the availability of the services. Are the workers’ services available to the general public?

Who is an Independent Contractor?

Independent contractors often advertise, maintain a visible business location or presence, and are available to the relevant market. Also, an independent contractor is generally free to seek out other business opportunities. Finally, the method of payment must be considered. What method of payment does the worker receive? Are they paid by the job or by the hour? Hourly, weekly, or similar basis for payment in return for services or labor generally is evidence of an employer/employee relationship. A flat fee is generally evidence of an independent contractor, especially if the worker incurs the expenses of performing the services. Again, just as with behavior control factors, in the financial control category, there is no one factor that takes precedence over the others. It is a matter of looking at the whole relationship and seeing where the preponderance of evidence lies.

Let’s start by taking a look at some of the elements which may be present in the relationship between the two parties. Is there a written contract? Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine a worker’s status. The IRS is not required to follow contracts stating that the worker is an independent contractor responsible for paying his or her own self-employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.


Businesses should consider whether there are employee-type benefits provided

Businesses should consider whether there are employee-type benefits provided. Employee benefits could include things like insurance, pension plans, paid vacations, and sick days and disability insurance. Businesses generally do not grant these fringe benefits to independent contractors. However, the lack of these type of benefits does not necessarily mean the worker is an independent contractor. Other questions are how permanent is the relationship? If you hire a worker with the expectation that the relationship will continue indefinitely rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer/employee relationship.

Are the services provided a crucial activity of the business? If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney it is likely that it will present the attorney’s work as their own and would have the right to control or direct that work. This would indicate an employer/employee relationship.


How to treat seasonal or part-time workers?

We often get questions from business owners about how to treat seasonal or part-time workers. For each worker you will need to look at all of the factors we have just discussed and see whether they indicate an employee or an independent contractor status. The length of time the worker performs services for you is not a standalone factor in determining his or her status. A worker can be an employee even if he or she only performs a few hours of services. It is important to remember that businesses must weigh the factors under all three categories of evidence when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee while other factors may indicate that the worker is an independent contractor. There is no set number of criteria that makes the worker an employee or an independent contractor. No one factor stands alone in making this determination. Also, factors which are relevant in one situation, may not be relevant in another. The key is to review the entire relationship, consider the degree or extent of all the factors in the right to direct and control, and finally, to document each of the factors used in coming up with the determination.


IRS Publication 1779, Independent Contractor or Employee

There is a host of useful information about worker classification available. There is the IRS Publication 1779, Independent Contractor or Employee; Publication 15A, Employer’s Supplemental Tax Guide; and IRS podcast and training materials available on the IRS website, As we end the worker classification part of the presentation we would like to pose our first question for the audience. Which of these are important factors in determining proper worker status?

When making a worker classification determination, the business should consider all aspects of the work relationship and make the decision based on all the factors. The business should not simply rely on one or two factors that may indicate the worker is an employee or an independent contractor. And finally, answer D is incorrect. It does not matter whether a worker is permanent or seasonal. The right to direct and control the worker is a key factor while considering the overall relationship.


Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax

A worker or firm may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax. The Form SS-8 is filed to request a determination of the status of a worker under the common law rules for purposes of federal employment taxes and income tax withholding. Additionally, the IRS developed Form 8919, Uncollected Social Security and Medicare Tax on Wages, to simplify the process for employees to report their share of uncollected social security and Medicare taxes due on their compensation when their employers have misclassified them as independent contractors. Additional information can be found in the instructions for Form 8919.