Using the "employee scenario," the Internal
Revenue Service/Social Security Administration will receive $13,688 between the
employer and employee for Social Security/Medicare tax withholdings and $14,983
in income taxes from the employee for a total of $28,671. Under
the "independent contractor scenario," the employer pays no taxes and the
employee pays $25,496 between self-employment and income taxes.
The difference of $3,175 is money you can bet
the United States Treasury wants.
The effects of our example are mild compared to what happens to many taxpayers.
Many times, the deductions an "independent
contractor" claims are far more substantial and, on audit, if the contractor is
really an employee, the results are devastating.
So how do you avoid the pitfalls of improperly classifying those who work for
you? Here is a list of 20 factors the IRS uses
in determining if a worker is an employee or independent contractor.
Even with the list, the factors on which are
discussed in the following paragraphs, you will still need to exercise judgment
when classifying your workers. As you read these
factors, bear in mind that the overriding issue is one of control; how much
control you have over the actions of the worker.
Instructions - If your worker is required to comply with your
instructions about when, where and how he or she is to work, they are ordinarily
treated as an employee. Independent contractors
normally are required only to produce a result, but control over how and where
the work is to be done is up to the contractor. Within
the limitations of a contract, the "when" the work is to be done is also up to
the contractor.
Training - If you train new personnel by requiring them to work
with experienced employees, require attendance at training meetings,
corresponding with the worker or otherwise taking the training, and cost
thereof, on yourself, your relationship is indicative of an employer-employee
relationship.
Integration - Does your worker perform services that your business
can’t live without? A high degree of reliance on
a worker for a business’ success, indicates that worker is more of an employee
than an independent contractor.
Services rendered personally - If a worker must perform the
services personally, the presumption is that the employer is interested in the
work being performed in a particular manner; thus indicating an
employer-employee relationship.
Hiring, supervising and paying assistants - If you, or your
worker, hire, supervise and pay assistants, this indicates an employer-employee
relationship. However, if a worker hires,
supervises and pays assistants pursuant to a contract under which that person
provides materials and labor, and the contract only calls for a specified
result, then this indicates a contractor relationship.
Continuing relationship - A continuing relationship indicates an
employer-employee relationship. For these
purposes, "continuing relationship" means work is performed at frequently
recurring although irregular hours.
Set hours - If you set the hours for the worker or require the
worker to be on site at specific hours, this indicates an employer-employee
relationship.
Full-time - If you require your worker to devote substantially all
of his or her working efforts to your business, then he or she is likely an
employee. Contractors are generally free to come
and go as long as the result is achieved and they are also free to work for
other customers or clients.
Working on employer’s premises - Requiring the work to be
performed on your premises suggests a worker is an employee.
Set order or sequence of work - If work must be completed in a
particular order or sequence set by you as employer, this suggests sufficient
control to classify the worker as an employee.
Oral or written reports - If you require the worker to provide
oral or written reports, then this suggests a degree of control over the worker
and may indicate employee status.
Payment by hour, week or month - Payment by the hour, week or
month, except as a convenient way to break up the total cost of a contract,
generally points to an employer-employee relationship. On
the other hand, payment on straight commission or by the job tends to point to
independent contractor status.
Payment of business or travel expenses - It’s presumed that if you
pay for your worker’s travel and other business expenses, you have some degree
of control over the worker’s business activities. If,
however, the worker provides labor and materials (including out-of-pocket
expenses) under a contract that requires only a specific result be achieved, you
have a stronger argument for the worker being an independent contractor.
Furnishing of tools and materials - If you provide the materials
and tools necessary to complete a task, you are dangerously close to having an
employee. Independent contractors generally
provide their own significant items of equipment and generally the necessary
material.
Investment - If a worker invests significantly in the facilities
needed to complete a job, this generally points to an independent contractor.
If you, rather than the worker, are required to
make the investment, you are probably looking at an employee and not a
contractor.
Who keeps the profit or pays for the loss - The incentive for
employees to work hard and make money is a periodic paycheck. In
general, you generally keep the profit, if any. Independent
contractors, on the other hand, rely solely on the profit generated by a
contract.
Working for more than one employer - We said earlier that a
contractor generally has more than just one customer. Intuitively,
the same person working for more than just one employer might indicate the
worker is a contractor. This is not, however,
always the case. You also have to look at other
control aspects to determine whether the worker is an employee of the entities
for which they work.
Services available to the general public - If a worker makes the
services rendered to you available to the general public on a regular and
consistent basis, this indicates that the worker is an independent contractor.
Right to fire - If you, as employer, have the right to discharge a
worker without incurring any contractual penalty, that person is most likely an
employee.
Right to quit - The converse of the right to fire is the right to
quit. If a worker can quit without notice and
incur no penalty, then that person is more of an employee than a contractor.
Conclusion
The IRS has developed a list to make things easier on employers in the employee
classification game. If you are like most
people, after you read that list, you find out things aren’t as simple as they
seem. For example, accountants and lawyers
regularly charge clients for out-of-pocket expenditures. Does
that make them employees? Our guess is no.
On the other hand, many contracts require only a
written notification of a contract termination and attach no penalty.
Then again, if you do not require a worker to be
at the office at a specified time, but just expect the work to be done, does
that necessarily mean the worker is a contractor? Again,
the answer is "not necessarily."
Each of these factors does not necessarily control the classification of a
worker by itself, but if, after looking at the factors and concluding you pretty
much control the business life of a worker, you probably have an employee.
If you need additional help
classifying a worker, remember that we are here to help. Just give us a
call!
Tax
Planning Archives
For More Information Contact:
Bucheri McCarty & Metz LLP
2366 W. Boulevard
P.O. Box 2147
Kokomo, IN 46904-2147
Telephone: (765) 236-2300
FAX: (765) 236-2333
Internet:
info@bmmcpas.com
