By: Kerri Tassin
In recent articles, I discussed self-employment tax issues and the sharing economy and focused on independent contractors and their tax responsibilities. But what if you’re an employer trying to determine whether the workers you hire should be treated as independent contractors or employees? What difference does worker classification make?
Whether an employer classifies workers as independent contractors or employees makes a difference for both the employer and the worker. This issue is complex, and the determination involves close evaluation of the facts and circumstances in each situation. No “one size fits all” rule applies.
Worker classification matters because the employer and worker’s tax responsibilities vary depending on the employment relationship. Generally speaking, independent contractors have responsibility for their own payroll tax reporting and payments, while employers of employees must withhold, report, and remit payroll taxes for their employees. In addition, year-end reporting for an independent contractor varies from that required for employees. Employers may be required to send a Form 1099-MISC to an independent contractor, showing how much the employer paid to the independent contractor during the year. On the other hand, employers will send a Form W-2 to employees, showing how much each employee earned during the year and the taxes withheld from those earnings.
So how does an employer begin to decide how to properly classify a worker as an independent contractor or an employee? Except in certain circumstances where statutes apply, the Internal Revenue Service and courts will examine certain characteristics of the employment relationship. Internal Revenue Publication 1779 breaks these characteristics, or factors, into three main categories: behavioral control, financial control and the relationship of the parties. According to Treasury Regulation Sec. 31.3121(d)-1, if the employer has the right to direct and control the means and results of the work, the worker should be classified an employee. It does not matter whether the employer actually exercises control, only that the employer has the right to direct and control.
According to Internal Revenue Manual Exhibit 4.23.5-1, behavioral control includes factors such as training and instruction. To what degree does the employer provide training and instructions for the work to be performed? Financial control includes factors such as whether the worker has a significant investment in facilities or tools of the trade, whether the worker incurs unreimbursed expenses, the worker’s opportunities to realize a profit or loss, and whether the worker makes his/her services available to the general public. Factors that may help determine the relationship between the parties include the degree of permanency of the working relationship, whether the worker receives any benefits, whether the parties have a contract, and whether either party has the ability to terminate the working relationship.
No one factor determines whether the employer should classify the worker as an independent contractor or an employee. The classification decision must take into account the type of work, relevant factors, and ultimately whether the relationship indicates that the employer has the right to direct and control. Proper determination of the worker’s classification matters to both the employer and the worker. The determination involves the consideration of many factors, and employers would do well to seek professional assistance in this matter.
The material in this article is for general informational purposes only and does not constitute tax or legal advice. Please consult with your own tax adviser regarding your personal tax situation.
Assistant Professor Kerri L. Tassin, CPA, JD teaches tax accounting classes in the School of Accountancy at Missouri State University.
This article appeared in the May 6, 2017 edition of the News-Leader and can be accessed online here.