© 2009 Paychex, Inc. All rights reserved. 1 Employees vs. Independent Contractors

© 2009 Paychex, Inc. All rights reserved.1

Employees vs. Independent Contractors


Some Employer Responsibilities for Employees

• Withhold income tax

• Withhold employee portion of social security and Medicare taxes

• Pay social security, Medicare, and FUTA taxes

• Provide SUI and workers’ compensation insurance

• Issue Form W-2 annually

• Report wages on Form 941 quarterly

• Provide fringe benefits, in accordance with company policy

• Comply with applicable federal, state, and local statutes (e.g., wage/hour laws, antidiscrimination laws)

• Comply with ERISA guidelines for administration of group pension plans and welfare benefit plans


Some Responsibilities for Independent Contractors

• Issue Form 1099-MISC at the end of the tax year


Making the Determination

• IRS control test

• Common law test

• Economic reality test

When making a determination, err on the side of employee classification to avoid potential back taxes, penalties, and fines associated with misclassification.


IRS Control Test

• Examines relevant facts within three primary categories to analyze worker status:

– behavioral control

– financial control

– relationship of the parties

• IRS 20-factor test still used as an analytical tool

• Consider all the facts; no single fact provides the answer.


IRS Control Test: Behavioral Control

Does the business have the right to direct and control the worker?

Consider:

Instructions – Who determines the following?

• When, where, and how to work

• Tools and equipment to use

• What assistants to use

• Where to purchase supplies

• What work must be performed

• Order or sequence of work to be performed

Training – Is the worker trained to perform services in a particular manner?


IRS Control Test: Financial Control

Does the business have the right to control or direct the financial and business aspects of the worker’s job?

Consider:• Extent of unreimbursed expenses

• Extent of worker’s investment

• Availability of worker’s services to relevant market

• Method of payment for services

• Ability for worker to make a profit or incur a loss


IRS Control Test: Relationship of the Parties

How do the parties perceive the relationship? Consider:

• Written contracts describing the intended relationship

• Fringe benefits provided (or not) to the worker

• The permanency of the relationship

• The type of work in relation to the principle activity of the business


When is the IRS Control Test Applied?

Generally, the IRS control test is considered/applied with respect to compliance with the following:

• Federal tax law

• Federal anti-discrimination statutes (sometimes combined with other tests)

• National Labor Relations Act

• Form I-9 requirements

• Worker Adjustment Retraining and Notification Act

• Employee Retirement Income Security Act


Common Law Control Test

• Initially applied to determine employer responsibility for employee actions

• Continues to be used by most courts in determining worker status and the applicability of various statutes

• A modification of the 20-factor test originally used by the IRS


Common Law Control Test:Factors Considered

• Skill level

• Tools and equipment

• Length of relationship

• Additional work

• Work schedule

• Method of pay

• Use of assistants

• Type of work relative to company’s ordinary course of business

• Self-employment status

• Fringe benefits

• Worker status for tax purposes


When is the Common Law Control Test Applied?

Generally, the common law control test is considered/applied with respect to compliance with the following:


• National Labor Relations Act

• Form I-9 requirements

• Worker Adjustment Retraining and Notification Act

• Employee Retirement Income Security Act


Economic Reality Test

• Looks at the relationship in its entirety, with a focus on the extent to which the worker is dependent on the relationship

• This is the most broad of all the tests.


Economic Reality Test: Factors Considered

• Degree of control

• Opportunity for profit or loss

• Investment in tools and equipment

• Special skills

• Permanency or exclusivity of relationship

• Type of work in relation to the core business


When is the Economic Reality Test Applied?

Generally, the economic reality test is considered/applied with respect to compliance with the following:

• FLSA/Wage and Hour law



State Laws

• Each state may have its own definition of “employee.”

• States may have more stringent regulations for determining worker status.


Consequences of Misclassification

• Back taxes– 1.5% of wages paid for failing to withhold employee’s income tax

– 20% of employee’s share of FICA taxes

– 100% of employer’s share of employer taxes

– 100% of FUTA taxes

• Unpaid overtime

• Back pay; front pay

• Benefits

• Attorney’s fees

• Civil and criminal penalties– Fines and penalties can be more stringent at the state level.

– Aggressive enforcement of classification can vary by state.


Civil and Criminal Penalties

• Fines and penalties may also apply at the state level.

• Enforcement of misclassification can vary by state.

• Federal penalties double for employers who fail to give workers who earn more than $600 each year a Form 1099-MISC.

• Employers may be subject to greater fines and penalties for intentional misclassification.


IRS Safe Harbors

Employers who unintentionally misclassify a worker may have a legal defense if they can show a “reasonable basis” for not treating the worker as an employee. Reasonable basis may include:

• Judicial precedence, published rulings, technical advice, etc.

• Past IRS audits

• Industry standards


Case Study: Schwind v. EW & Associates (EWA)

Schwind worked for EWA from April 1998 to October 2002. Responsibilities included interviewing and hiring trainers who provided consulting services for clients. Profits were split 50/50 with EWA.

From April 1998 until January 2001 and June 2002 through October 2002, Schwind was classified as an IC.

From January 1, 2001 through June 2002, he was classified as an employee, earning $140,000 total annual compensation.

Both parties agreed Schwind performed similar duties as an employee and IC, but did not agree on level of authority.


Testimony of Parties

Employee’s version:

• Salesperson only

• Performed work for EWA only

• EWA supervised work

• Prohibited from subcontracting work

• Performed same work as an employee and an independent contractor

Employer’s version:

• Able to choose trainers for clients

• Participated in interviewing potential trainers

• Directed work of trainers

• Could propose business deals and offer discounts

• No guidelines on how or when to complete work

• Supervised several other workers


Court’s Analysis: Was Schwind improperly classified as an independent contractor?

Using the economic reality test, five factors were considered:

• Degree of employer’s control

• Worker’s opportunity for profit or loss and investment in the business

• Degree of skill and independent initiative required to perform the job

• Permanence or duration of relationship

• Extent to which the worker was an integral part of the employer’s business


Court’s Decision

Based on the facts presented, how do you think the court ruled?


Resources• 1099: Employee vs. Independent Contractor

http://www.paychex.com/pdf/1099.pdf (also available through Order Entry - #94995)

• Independent Contractor or Employee (publication 1779)

http://www.irs.gov/pub/irs-pdf/p1779.pdf

• IRS Web site

www.irs.gov

• Form SS8

http://www.irs.gov/pub/irs-pdf/fss8.pdf

• IRS Ten Tips for Business Owners

http://www.irs.gov/newsroom/article/0,,id=173423,00.html

• DOL Fact Sheet # 13 (Employment Relationship under the FLSA)

http://www.dol.gov/esa/regs/compliance/whd/whdfs13.htm


Questions?

Documents

© 2009 Paychex, Inc. All rights reserved. 1 Employees vs. Independent Contractors