Control Freak: Are Your Independent Contractors Actually Employees?

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It’s all about control.  Regardless of what you call them, your “independent contractors” may very well qualify as employees for tax purposes.  The degree of control the hiring party exerts over the party performing the work largely determines whether the person or company is an independent contractor or employee, regardless of the hiring party’s intention.  Ensuring you have the proper contracts in place that clearly lay out the responsibilities of both the worker and the employer is an important step. These agreements should address specific information about things like the availability of employee benefits and the party responsible for tax reporting, among a number of factors that define the nature of the relationship between the hiring party and the contractor or employee.

The IRS 20 factor test for employment status, available here, is a helpful guide to learn the basics of what the Internal Revenue Service considers in determining whether a worker is an employee.  Again, these factors are largely focused on the overall control exerted by the hiring party over the worker, in three main categories:  behavioral, financial, and the type of relationship.  Some of the most telling factors include whether the hired party is paid in a lump sum or by an hourly fee, whether the hiring party controls the hired party’s set hours, if the hired party must perform according to specific instructions and training,  if assistants to the worker are hired by and paid directly by the hiring party, whether the worker must devote substantially all their time to the performance of services for the hiring party, if the work is ongoing or project based, whether benefits are provided, and whether the employer exercises other kinds of supervisory control. The more control the employer exerts over the worker, the more likely it is that the relationship is that of employer-employee.  Adding to many people’s confusion, there is no magic or set number of factors that automatically makes the worker an employee or an independent contractor. No one factor alone makes this determination, and factors which are relevant in one situation may not be relevant in another.

From the worker’s perspective, whether you are an independent contractor or employee is an extremely important distinction.  As an independent contractor, you are generally considered self-employed for tax purposes.  This means you are personally responsible for a number of tax responsibilities, such as filing and reporting requirements, which also extend to any subcontractors hired by the independent contractor.  See here for a number of forms you may be required to file if you are truly an independent contractor.

As an employer, it is essential that you determine whether your worker(s) are independent contractors or employees.  The Department of Labor recently addressed to the increased level of scrutiny it will be applying to employers treatment and classification of workers, available here.  Consequences for business owners can be extremely costly, and employers could find themselves unexpectedly responsible for paying the worker wages due under the Fair Labor Standards Act (FLSA)—including reimbursement for overtime and minimum wage payments, payment of back taxes and fines for state income taxes, Medicare, Social Security and unemployment, payment of workers’ compensation benefits, and provision of benefits like health insurance to newly classified employees.

What You Can Do If You Don’t Know Whether a Worker is an Employee or an Independent Contractor

WORKER OR EMPLOYER

File a Form SS-8

If you want to obtain a determination from the IRS directly as to whether a worker is an independent contractor or employee, either the worker or the company may file a Form SS-8 if, after reviewing evidence in the three categories, it is still unclear whether a worker is an employee or an independent contractor.  The IRS will then review the facts and circumstances to make an official determination of the worker’s status, though this can take 6 months or more.  In particular, businesses that regularly hire the same types of workers to perform recurring services may want to consider filing Form SS-8.

EMPLOYER

Potential Relief

If you have or believe you may have a reasonable basis for not treating a worker as an employee, you as the employer could be relieved from having to pay employment taxes for that particular worker.  However, in order to benefit in this way, you must file all federal information returns on a basis that matches your treatment of the worker.  Important to note is that you must not have treated any worker holding a position that is substantially similar as an employee for any time period that began after 1977.  There are a number of publications on this topic of “Employment Tax Relief Requirements,” one of which may be found here.

Voluntary Classification Settlement Program

A new optional program called the Voluntary Classification Settlement Program (VCSP) provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods.  You can apply for this program if you have, or believe you may have, misclassified employees for a minimum of three years, and are not currently the subject of an IRS employment tax audit.  If eligible, this program affords partial relief from federal employment taxes for taxpayers who agree to, going forward, treat their workers as employees.   You can apply to participate in this program to see whether you qualify by filing the Application for Voluntary Classification Settlement Program, and cooperating with the IRS.  Keep in mind that to pursue this program, you need to fill out and submit this application at least 60 days prior to when you wish convert your treatment of previously incorrectly classified independent contractors as employees.

WORKERS

Misclassified Workers Can File Social Security Tax Form

Workers who believe they have been improperly classified as independent contractors by an employer can use a form called the Uncollected Social Security and Medicare Tax on Wages to calculate and report their share of uncollected Social Security and Medicare taxes due on their compensation.  Sometimes approaching an employer with this information  can help the parties work together to come to a resolution and adjustment of terms for the future.

File a Claim Through the Department of Labor Directly

If employers and workers are unable to work out the correct nature and treatment of the worker’s performance of services, the worker can seek the assistance of the Department of Labor, directly.  The Department of Labor strives to ensure that workers are provided important workplace protections, such as minimum wage and unemployment insurance if they are, in fact, employees.  While for many businesses the improper classification may be inadvertent, the concern is that some employees may be intentionally misclassified as a means to cut costs and avoid compliance with labor laws.   Workers can file a claim through the Department of Labor Wage and Hour Division to seek assistance.  The Department has also made helpful resources available to educate workers about their rights including whether you are an independent contractor or employee.  This Department has seen a dramatic increase in complaints in recent years and, as a result, has announced that it will be enforcing these provisions more strictly in an effort to better protect workers’  rights.  Specifically, the Department points to the FLSA’s test as clarifying and helpful.

The FLSA’s definition of employ as “to suffer or permit to work” and the later-developed “economic realities” test provide a broader scope of employment than the common law control test.  Under the FLSA, courts use the multi-factorial “economic realities” test, which is focused on control and whether the worker is truly economically dependent on the employer or in business for him or herself.   Application of the economic realities test in view of the broad definition of “employ” under the Act, results in the determination that most workers are employees under the FLSA.  Perhaps the most clarifying statement for workers and employers alike is the clarification that “the goal is not simply to tally which [of the IRS 20 Factors] are met, but to determine whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor).”

Educate yourself and learn your rights, and know that we are able to assist in any way necessary, whether to draft employee and independent contractor agreements for employers, or to review documents and and help negotiate appropriate terms and resolutions for workers and employers alike.  Contact us at any of our locations for further information and assistance.