WORKER CLASSIFICATION

Transcription

1 100 Arbor Drive, Suite 108 Christiansburg, VA Voice: FAX: Providing Professional Business Advisory & Consulting Services Douglas L. Johnston, II WORKER CLASSIFICATION EMPLOYEE OR INDEPENDENT CONTRACTOR? GET IT RIGHT THE FIRST TIME!

2 CONTENTS Classification of Workers 1 Challenges to Worker Classification 2 Determination of Proper Classification 3 Summary of Twenty Common Law Factors 4 IRS Examples of Worker Classification 6 Appendix: IRS Form SS-8

3 CLASSIFICATION OF WORKERS Proper classification of workers for tax purposes is one of the most significant issues facing many start-up businesses. Small business owners tend to take the path of least resistance and classify workers as independent contractor when they are in reality acting as employees. Misclassification can be catastrophic to a small business if the Internal Revenue Service or the workers themselves challenge the classification. Worker motivations to be classified as independent contractors: Ability to choose and purchase benefits independently Ability to deduct business-related expenses above the line rather than as itemized deductions Increased take-home pay since withholding does not apply Intent to avoid tax on under the table earnings Business motivations to classify workers as independent contractors: Ability to exclude workers from employee benefit plans Ability to avoid minimum wage and overtime requirements Simplified recordkeeping and other administrative cost savings Intent to avoid payroll taxes 1

4 CHALLENGES TO WORKER CLASSIFICATION The Internal Revenue Service is interested in challenging the classification of workers as independent contractors because it makes enforcement of payroll and income tax requirements much more costeffective. The big stick the Internal Revenue Service carries is the legal authority to hold employers and/or corporate officers liable for all employment taxes for misclassified workers. As Microsoft Corporation learned, it is sometimes the workers themselves who challenge their classification. Some Microsoft workers realized that it would be in their best interest to have Microsoft reclassify them as employees for benefit purposes. The courts agreed with the employees and forced Microsoft to pay for overtime and provide employee benefits retroactively for the employees. Misclassified workers are in a unique position to blow the whistle on employers and possibly have their tax bill paid by the employer! Potential costs of challenges to worker classification: Liability for employment taxes, penalties, and interest Minimum wage, overtime, and unemployment claims Back payments for employee benefits Possible assumption of liabilities for workers job-related injuries, accidents, etc. Civil or criminal charges for violation of federal and state employment laws Litigation and settlement costs 2

5 DETERMINATION OF WORKER CLASSIFICATION There is no single litmus test to easily determine the proper classification of workers. The Internal Revenue Service acknowledges that the classification depends on the occupation and the factual context in which the services are performed. Over the years, the Internal Revenue Service and the courts have developed twenty common law factors to consider in determining the proper classification of a worker. The twenty factors are described in the table on the following pages along with some examples provided by the Service in Publication 15A. The Internal Revenue Service has incorporated the twenty factors into Form SS-8, which businesses or workers can file with the Service for a determination of the proper classification. 3

6 Employee Characteristics Independent Contractor Characteristics Instructions Worker must comply with employer s instructions on when, where, and how to work. Worker is accountable to employer for results of services, but generally not the methods. Training Employer provides training. Worker uses his/her own methods and/or obtains his/her own training. Integration Services Rendered Personally Hiring, Supervising, and Paying Assistants Continuing Relationship Set Hours of Work Full Time Required Work on Employer Premises Order or Sequence The success or continuation of the employer s business depends significantly upon the performance of the worker s services. Worker must render the services personally. Employer is responsible for hiring, supervising, and paying assistants for the worker. Relationship is continuous and/or frequently recurring. Employer establishes set hours of work. Worker must devote substantially full time to the employer. Work is performed on the premises of the employer and/or the employer dictates a designated route, territory, or location. Worker must perform services in the order or sequence set by the employer. The worker s services are incidental or secondary in the employer s business. Services may be performed by the worker or by an agent, employee, or sub-contractor of the worker. Worker provides labor for services and is responsible for hiring, supervising, and paying assistants. Term of relationship is finite. Worker determines hours of work. Worker is free to work when and for whom he/she chooses. Work may be performed off the premises of the employer, such as at the worker s own home or place of business. Worker may determine the order or sequence of services. 4

7 Oral or Written Reports Payment by Hour, Week, or Month Payment of Business Expenses Furnishing of Tools and Materials Significant Investment Realization of Profit or Loss Multiple Employers Marketing Services to the Public Right to Discharge Right to Terminate Employee Characteristics Worker must submit regular or written reports to the employer. Worker is paid based on time incurred in performance of services. Employer pays the worker s business and/or travel expenses. Employer furnishes significant tools, materials, and/or equipment. Worker is dependent on employer for facilities used in the performance of services. Worker is compensated for time/efforts and does not realize a profit or suffer a loss as a result of the services. Worker performs substantially all services for one employer. Worker performs services exclusively for employer, possibly subject to noncompete agreements, etc. Employer has the right to discharge the worker. Worker has the right to terminate relationship without incurring liability. Independent Contractor Characteristics Regular reports are not required the worker is only accountable for final results. Worker is paid by the job or on a commission. Worker is responsible for his/her own business and/or travel expenses. Worker furnishes significant tools, materials, and equipment. Worker invests in facilities used in the performance of services that are not typically maintained by employees. Worker can realize a profit or suffer a loss as a result of services. Worker performs services for multiple employers at the same time. Worker consistently offers similar services to the public. Worker cannot be discharged so long as he/she produces the results specified in the contract. Worker may be subject to penalties or other loss for premature termination of relationship. 5

8 IRS EXAMPLES OF WORKER CLASSIFICATION Building and Construction Industry Jerry Jones has an agreement with Wilma White to supervise the remodeling of her house. She did not advance funds to help him carry on the work. She makes direct payments to the suppliers for all necessary materials. She carries liability and workers' compensation insurance covering Jerry and others that he engaged to assist him. She pays them an hourly rate and exercises almost constant supervision over the work. Jerry is not free to transfer his assistants to other jobs. He may not work on other jobs while working for Wilma. He assumes no responsibility to complete the work and will incur no contractual liability if he fails to do so. He and his assistants perform personal services for hourly wages. Jerry Jones and his assistants are employees of Wilma White. Milton Manning, an experienced tilesetter, orally agreed with a corporation to perform full-time services at construction sites. He uses his own tools and performs services in the order designated by the corporation and according to its specifications. The corporation supplies all materials, makes frequent inspections of his work, pays him on a piecework basis, and carries workers' compensation insurance on him. He does not have a place of business or hold himself out to perform similar services for others. Either party can end the services at any time. Milton Manning is an employee of the corporation. Bill Plum contracted with Elm Corporation to complete the roofing on a housing complex. A signed contract established a flat amount for the services rendered by Bill Plum. Bill is a licensed roofer and carries workers' compensation and liability insurance under the business name, Plum Roofing. He hires his own roofers who are treated as employees for Federal employment tax purposes. If there is a problem with the roofing work, Plum Roofing is responsible for paying for any repairs. Bill Plum, doing business as Plum Roofing, is an independent contractor. Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive 6

9 $6,400. She also performs additional electrical installations under contracts with other companies, which she obtained through advertisements. Vera is an independent contractor. Trucking Industry Rose Trucking contracts to deliver material for Forest Inc. at $140 per ton. Rose Trucking is not paid for any articles that are not delivered. At times, Jan Rose, who operates as Rose Trucking, may also lease another truck and engage a driver to complete the contract. All operating expenses, including insurance coverage, are paid by Jan Rose. All equipment is owned or rented by Jan and she is responsible for all maintenance. None of the drivers are provided by Forest Inc. Jan Rose, operating as Rose Trucking, is an independent contractor. Computer Industry Steve Smith, a computer programmer, is laid off when Megabyte Inc., downsizes. Megabyte agrees to pay Steve a flat amount to complete a one-time project to create a certain product. It is not clear how long that it will take to complete the project, and Steve is not guaranteed any minimum payment for the hours spent on the program. Megabyte provides Steve with no instructions beyond the specifications for the product itself. Steve and Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to pay Federal and state taxes, and receives no benefits from Megabyte. Megabyte will file a Form 1099-MISC. Steve does the work on a new high-end computer that cost him $7,000. Steve works at home and is not expected or allowed to attend meetings of the software development group. Steve is an independent contractor. Automobile Industry Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works six days a week and is on duty in Bob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She is required to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob also pays the cost of health insurance and groupterm life insurance for Donna. Donna is an employee of Bob Blue. 7