Many companies face the daunting challenge of properly classifying workers as either employees or independent contractors. There is no uniform definition of the term “employee” in the Internal Revenue Code and as such, taxpayers must rely upon common-law rules which have their origin in court cases. Despite this lack of direction provided in the statutes, there are serious consequences for failing to properly classify your workers.
Companies that classify their workers as employees are responsible for a host of employment taxes including Social Security and Medicare (commonly known as “FICA”), Federal Unemployment, and certain state level taxes. Additionally, there are anti-discrimination rules that require those individuals to participate in employee benefit programs including health insurance, pension, etc. Conversely, workers classified as independent contractors do not subject the company to employment taxes or fringe benefits. In the event of an audit by the Internal Revenue Service, the failure to have properly classified your workers can result in the assessment of substantial delinquent tax liabilities along with penalties and interest. Therefore, companies should exercise extreme care in making this facts and circumstances-based judgment regarding their workers.
Under the “common law” rules developed by the courts, workers are generally deemed employees for federal tax purpose if the employer has the right to control and direct the worker with regard to what he or she does and the manner in which the work is to be performed. It is not necessary that the company actually direct or control the employee; the mere right to do so is enough to cause the worker to be deemed an employee. Courts have utilized a facts and circumstances approach in these worker determination cases that include the consideration of such items as:
- A worker who must comply with instructions about when, where, and how he or she is to work may be deemed an employee.
- Ongoing training provided by the company to the worker is a strong sign of an employer-employee relationship.
- A worker who is required to personally render the services may be deemed an employee.
Hiring, supervising or providing assistants to the worker is indicative of an employer-employee relationship.
- Workers who provide service to the company on a continuing and regular basis may be acting like employees.
- Workers who are required to perform on the Company premises may be deemed employees.
- Workers who perform in a certain manner or order as dictated by the company are exhibiting traits of an employee.
- Workers who are required to submit reports to the Company may be acting as an employee.
- Compensation methods including hourly, weekly, or monthly typically point to an employer-employee relationship.
- Tools furnished by the company to the worker may be indicative of an employer-employee relationship.
- Workers who have the ability to realize a profit or suffer a loss are generally deemed to be independent contractors.
- Workers who render services for a variety of unrelated entities are typically deemed to be independent contractors.
- Workers who avail themselves to the public on a regular and consistent basis are generally deemed to be independent contractors.
The above list is by no means all inclusive. There is no standard for how many of these factors must be present nor have the courts applied these interpretations universally. Companies that have concerns about their worker classifications should consider consulting with appropriate legal and accounting professionals for assistance in this very complex area.