IRS & States Team up to Find Independent Contractors
The IRS and the states know how tempting it is to classify workers as Independent Contractors because of saved employment taxes.
That’s why Delaware and Wisconsin are targeting the construction industry with penalties of $1,000-$5,000 per violation.
Other states such as Indiana and Nevada and Ohio are starting to share information on misclassified workers and similar violations.
Expect your state to be watching you for misclassifying employees as Independent Contractors.
Determining a workers’s status depends on the facts that define both the entity and relationship of the entity to the worker at the time that the services are rendered.
Here are the two categories of workers that the IRS and states are focusing on:
Common Law Employee - Works for and performs services under the control of the entity that pays for the services.
Independent Contractor - An individual in business for him-/herself whose services are free of control from the entity paying for the services.
Employment taxes apply soley to employee wages. These include FITW, employee and employer FICA, and FUTA.
States may have SITW, SUI and disability.
A business normally is not required to withhold from payments to Independent Contractors, but there are exceptions in some states.
Classification of Employees vs Independent Contractors
Classification depends on the degree of control exercised by the entity. Evidence of control vs independence fall into 3 categories: behavioral control, financial control, and the relationship between the parties:Behavioral Control: Facts that indicate whether the entity has the right to direct and control how the worker does the task for which the worker is paid including the type and degree thereof.
- Instructions given to an employee: An employee is generally subject to the business' instructions about when, where, and how to work. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work is done.
- Training given to the worker: Although an employee may be trained to perform services in a particular way, Independent Contractors ordinarily use their own methods.
Financial Control: Indications of the entity’s right to control the business aspects of the worker’s job include:
- Unreimbursed Business Expenses: Independent Contractors are more likely to have unreimbursed expenses than employees.
- The Worker's Investment: An Independent Contractor often has a significant investment in the “facilities” used to perform services for someone else, but this is not mandatory.
- To What Extent the Worker' Services are Available to Other Entities: Employees tend to work for a single business.
- How the Business Pays The Worker: An employee generally is paid by the hour, week, or month. An Independent Contractor usually is paid by the job, although in professions, such as law, Independent Contractors are paid an hourly rate and are nevertheless still Independent Contractors.
- The Extent in Which the Worker Can Realize a Profit or Incur a Loss: An Independent Contractor can make a profit or have a loss.
Type of Relationship: Facts that reveal the type of relationship between the entity and worker include:
- Written contracts describing the type of relationship the parties intend to create.
- Whether the entity offers the worker employee-type benefits-e.g., insurance, a pension plan, vacation pay, sick pay.
- Permanency of the relationship. Expecting a worker to stay with you indefinitely rather than for a specific project or period is generally evdidence of an employer-employee relationship.
- The extent to which the services performed by the worker are a key aspect of the entity’s regular business. If a worker’s services are a key aspect of the entity’s business activity, it is more likely that the entity has the right to direct and control those services, indicating an employer-employee relationship.
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For official IRS guidance, use Pub. 15-A. For related publications that give additional details, go to www.irs.gov and in the search box, type “employee vs. IC.” If you still don’t know if a worker is an employee, file Form SS-8 with the IRS to get a determination.