Introduction
In an employer/employee relationship, the employer has the right to control and direct the employee. An employee is subject to the will and control of the employer. The employer controls not only what tasks will be performed, but also how these tasks will be performed (see Treasury Regulation §31.3401(c)-1(f) and Internal Revenue Code (IRC§) Section 31.3401(c)) .
Qualified real estate agents and direct sellers are treated as independent contractors and not employees (IRC§3508(a)). Statutory employees include certain drivers, life insurance salespeople, those who work at home, etc., and are treated as employees for FICA tax purposes (IRC§3121(d)(3)).
Most of the controversy between employees and self-employed independent contractors arises from the desire of the taxpayer receiving services to avoid the employer’s payroll taxes and benefits. Many employers try to evade their responsibility to pay employment taxes by trying to treat “employees” as if they were “self-employed.” The Internal Revenue Service (IRS) aggressively pursues these cases imposing significant fines. When a taxpayer’s status is in question, the IRS will generally attempt to classify the taxpayer as an employee, a status that maximizes overall tax revenue collection.
Specifically, employers are trying to avoid:
(1) Employer portion of FICA taxes (at 7.65%),
(2) Employer Paid FUTA (Federal Unemployment Tax Assistance),
(3) SUTA paid by the employer (State Unemployment Tax Assistance),
(4) Workers’ compensation insurance, and
(5) Administrative reporting and documentation requirements.
Taken together, the payroll taxes paid by the employer can easily amount to 25% of the employee’s gross salary. This ignores any medical, dental, profit-sharing, fringe benefits, or retirement benefits that companies may also provide to their employees.
The best defense against an IRS effort to reclassify personnel as “employees” is to make sure these taxpayers want to be classified as self-employed. How is this accomplished? First, make sure that the facts and circumstances surrounding their relationship with you support their status as an independent contractor. Second, make sure these service providers are adequately compensated for their work. Finally, it may be to your advantage to ensure that they are receiving high-quality professional guidance toward tax minimization.
The first concern is addressed in the 20 factors used by the IRS to determine employee vs. self-employed independent contractor status.
20 Factors for Employee/Self-Employment Status
To reach a decision regarding a taxpayer’s status, the IRS looks at 20 factors, listed below. No single factor is used to determine a taxpayer’s status or relationship to another taxpayer. However, the facts and circumstances surrounding the relationship between two taxpayers are supported or not.
These factors are present or absent, as follows:
(1) Education
(2) Training
(3) Integration of duties
(4) Services rendered personally
(5) Recruitment, supervision and payment of assistants
(6) Ongoing relationship
(7) Established working hours
(8) Full-time requirement
(9) Work in “employment” premises
(10) Order or sequential nature of tasks
(11) Oral or written reports
(12) Pay by the hour/week/month/etc.
(13) Payment of business trips
(14) Tools or materials provided by the “employee”
(15) Significant investment
(16) Realization of gains/(losses)
(17) Multiple Employers
(18) Availability of the service to the general public
(19) Right of dismissal
(20) Right to terminate
Employee/Employer Status
The presence of (1) instruction, (2) training, or (3) the integration of duties with those of employees, or (10) the inherent sequential nature of tasks suggests the status of the employee. The presence of (4) personal servants (eg, making coffee or picking up the boss’s laundry) or responsibilities that involve (5) hiring, training, or supervising others also suggests employee status.
A (6) ongoing relationship with (7) set work hours and (8) a full-time requirement is typical of an employee. The required submission of (11) oral or written reports, especially when periodic, or (12) periodic payment (by the hour, week, or month), and/or (13) reimbursement for business travel, especially on forms provided by “employer” also supports employee status.
If a contributor (14) provides tools or materials used to complete tasks to another contributor, an employer/employee relationship is supported. This is further supported if these items do not require (15) a significant investment on the part of the party performing the tasks.
The absence of business risk, or (16) profit or loss, on a job-by-job basis (or otherwise), supports employee status. If the taxpayer who provides the services does so for (17) only one other taxpayer and (18) does not provide these or other services to the general public, the status of employee is suggested.
Employee status is supported by the presence of the right to (19) dismiss and/or (20) terminate services, or by the understanding that the service provider may be subject to dismissal or termination.
Independent Contractor/Self-Employment Status
Independent contractors do not require (1) instruction or (2) training. They are hired to perform services because they have experience. Your (3) duties may be integrated with the duties of others and (10) may even be sequential (for example, electrician, plumber, and carpenter in building construction), but not as significantly as employee status, per se. , be necessary.
Independent taxpayers are not required to (4) provide personal services to the taxpayer who hires them. They are also not required to (5) hire, supervise, or pay others, unless they have their own employees. The latter reinforces and supports their status as self-employed independent contractors.
Self-employed taxpayers (7) set their own work hours, (8) are not required to work a 40-hour week, or (9) perform work at established locations. However, the nature of the task may require the presence of these elements for the self-employed taxpayer.
Self-employed independent contractors (11) are not required to provide oral or written reports, but may choose to provide information in a billing statement on their own letterhead, etc. They are not paid (12) on regular pay days, but may bill their clients at an hourly rate and are paid at the end of the month or some other regular billing cycle. The self-employed taxpayer may also request (13) reimbursement for business travel, preferably at a predetermined rate, and upon receipt of a statement.
Independent contributors make (15) significant investments in (14) tools and/or materials that they use to perform tasks. They do so in anticipation of the (16) realization of a gain or loss. This class of taxpayer provides services to the general public (18) and has (or has the potential to have) (17) multiple clients.
The self-employed taxpayer cannot be (19) discharged or (20) terminated, per se, but may not be hired for future assignments if their work turns out to be unsatisfactory. This is understood and does not require formalization. Similarly, the self-employed taxpayer does not normally have the right to fire or lay off the employees of those for whom they are hired, unless this is the very nature of the business in which the independent contractor working is involved. on their own.
A typical fact pattern
In general, cases where a business improperly treats an “employee” as an “independent contractor” evolves to the attention of the IRS, as follows:
First, a company “hires” someone to provide services. The person hired is unable to obtain gainful employment elsewhere and agrees to the terms of the partnership: be treated, inappropriately, as an “independent contractor.” This agreement is, in effect, under duress.
Second, the employer issues a Form 1099 for services rendered to the business. Failure to file Form 1099 results in penalties that are quite independent of employers’ failure to collect and pay FICA and payroll taxes. Form 1099 contains the independent contractor’s Social Security number (SSN), which allows you to compare what the so-called independent contractor reports as income and what the business has paid this individual.
Third, the so-called independent contractor is surprised to receive a notice from the IRS that the amount of income or classification of income they reported does not “match” what the business independently reported to the IRS. They owe additional federal income taxes and self-employment taxes. They may or may not receive a similar notification from the state tax authority.
Fourth, the “independent contractor”, now aware of the importance of the self-employment tax and the tax liability to which he is subject, attempts to establish his status and an “employee”, which would subject the employer to the employer’s responsibility. part of FICA taxes and allow the employee to avoid self-employment taxes that would otherwise result. It may take approximately 24 months for all of these events or this sequence of events to occur, but, if it is “profitable” for the IRS, an investigation is conducted and the “employer” has risked an audit to identify others.” employees” incorrectly. classified as “independent contractors” by the employer.
Summary
The best way to ensure the self-employed or self-employed status of those you contract with is to ensure that they want to be classified as self-employed. This suggests that they have an understanding of the tax savings that are possible through independent contractor or self-employment status, as opposed to employee status. Generally, when the IRS makes efforts to reclassify a self-employed independent contractor as an employee, this effort is initiated by the “employee.” Often this is the result of the “employee’s” failure to meet estimated tax payments, and is their reaction to the surprise of a federal tax liability and self-employment at the end of the year. So if you can avoid the occurrence of these year-end surprises for those you contract with, you can also minimize your surprises from the IRS.
Perhaps the most important factors in establishing a taxpayer’s non-employee or self-employment status are (1) the provision of statements upon completion of the contractual assignment and (2) the establishment and maintenance of business cards and account statements. with logo. If those you contract with present you with statements and have business cards, business licenses, etc., they are much more likely to be presumed to be self-employed. Of course, the above twenty facts and circumstances will be considered to avoid any “sham” or attempt to avoid legal withholding and employment tax obligations.
Feel free to post or reproduce anywhere as long as you provide a copy and/or notify the author.