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Independent Contractor or Employee? (Part 2): The IRS Perspective

This subject is covered in four parts. The first article provides an introduction and focuses on the classification for the purposes compliance with the Federal Labor Standards Act (FLSA) enforced by the U.S. Department of Labor (DOL). The second article focuses on the classification under the Internal Revenue Service (IRS). The third article covers the criteria used under Florida common law, and the fourth article addresses the criteria under the Florida Workers’ Compensation Statute.[1]

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The classification of whether a worker is an employee or an independent contractor for the purposes of federal taxation is based on factors laid out by The Internal Revenue Service (IRS). The factors are weighed in the context of the work relationship, the type of work performed, and other circumstances. A main focus under the IRS factors is the level of control the employer exercises over the worker.

UntitledIRS criteria to determine who is an employee vs. who is an independent contractor

The IRS looks at 20 factors to help distinguish between an employee and an independent contractor. (U.S. Internal Revenue Ruling 87-41). The factors touch on three main areas: behavioral control, financial control, and relationship. These criteria are not individually determinative, and they are evaluated in the context of the industry and the services offered.

 

  1. If the worker must comply with specific instructions given by the person or persons for whom the services are performed, this points to employee status.
  2. If service recipient trains the worker, this points to employee status (particularly if the training is offered by another employee).
  3. If the worker’s services are integrated into the business operations of the service recipient, this points to employee status.
  4. Services Rendered Personally. If the services must be rendered personally, there is a presumption that the person receiving the services is interested in the methods used to accomplish the work, as well as in the results. This points to employee status.
  5. Hiring, Supervising, and Paying Assistants. If the worker hires, supervises, and pays assistants pursuant to a result-driven “materials and labor” contract, this indicates an independent contractor status.
  6. Continuing Relationship. A continuing relationship between the worker and the person for whom the services are performed indicates an employer-employee relationship.
  7. Set hours of work. If the worker has to follow work hours established by the person receiving the services, this is a factor indicating that the worker may be an employee.
  8. Full time required. If the worker must dedicate substantially full time to the business of the person or persons for whom the services are performed, this may point to an employee relationship, as an independent contractor is free to work whenever and for whoever he or she chooses.
  9. Doing Work on Employer’s Premises. If the work is performed on the premises of the person requesting the services, this suggests the worker is an employee. However, this factor, as the others, is evaluated within the context of the work performed.
  10. Order or Sequence Set. If a worker must perform services in the order or sequence set by the requester, this suggests employee status, particularly if the service requester retains control over the decision to set an order for service delivery.
  11. Oral or Written Reports. A requirement that the worker submit regular or written reports to the person receiving the services suggests the worker may be an employee.
  12. Payment by Hour, Week, Month. Payment by the hour, week, or month generally points to an employer-employee relationship. Payment made by the job or commission suggests that the worker is an independent contractor.
  13. Payment of Business and/or Traveling Expenses. If the person receiving the services regularly organizes and pays the worker’s business and/or traveling expenses, this suggests the worker may be an employee.
  14. Furnishing of Tools and Materials. The provision of significant tools, materials, and other equipment to the worker suggests an employer-employee relationship.
  15. Significant Investment. If the worker invests in facilities used by the worker in performing services (e.g., an office rented by an unrelated party), this suggests an independent contractor relationship.
  16. Realization of Profit or Loss. A worker who experiences a profit or loss as a result of their services (beyond what an employee would perceive from a paycheck) is generally an independent contractor.
  17. Working for more than one firm at a time. If a worker performs meaningful services for multiple of unrelated parties at the same time, this suggests the worker is an independent contractor.
  18. Making service available to the general public. Making his or her services available to the general public regularly suggests that the worker is an independent contractor.
  19. Right to discharge. An employer’s right to fire a worker suggests that the worker is an employee.
  20. Right to terminate. If the worker has the right to terminate the relationship at any time, this suggests that the worker is an employee.

Safe Harbor

Section 530 of the Revenue Act of 1978 is a safe harbor provision that prevents the IRS from retroactively reclassifying “independent contractors” as employees and subjecting the employer to federal employment taxes, penalties and interest for such misclassification. It was enacted in response to taxpayer complaints that the IRS was too aggressive with respect to worker misclassification. Originally intended as a temporary measure, it has since been made permanent through three different amendments.

In order for an employer to qualify for section 530 relief, it must have:

  1. Consistently treated the workers (and similarly situated workers) as independent contractors;
  2. Complied with the Form 1099 reporting requirements with respect to the compensation paid the workers for the tax years at issue; and
  3. Had a reasonable basis for treating the workers as independent contractors.

Section 530 does not validate workers as independent contractors. Instead, it classifies them as “non-employees” for federal employment tax purposes. Section 530 also does not apply for purposes of federal classifications (e.g., under the U.S. Department of Labor).

It is important to note that application of Section 530 relief has been traditionally challenging. It is fact-intensive and it has been reported that IRS agents are not always clear on how to apply it to a given set of facts.

Best Practices

As business models and hiring practices evolve, employers seeking efficiency and economy become more vulnerable, especially from a tax liability standpoint. The IRS has increasingly focused on employers engaging independent contractors to perform work that has traditionally been performed by employees. In these situations, determining whether a worker is an independent contractor or an employee can be challenging.

Therefore, it is in the employer’s best interest to engage the assistance of an attorney to identify potential vulnerabilities. Workers seeking to protect their employee benefits can consult with an attorney to better understand their rights and responsibilities in a work relationship, particularly when asked to become independent contractors in a situation where they believe they should be employees.

Whether you are an employer, employee, or independent contractor, the Orlando employment law attorneys of Burruezo & Burruezo can assist you in assessing an independent contractor vs. employee situation and offer competent legal representation, if necessary. Click here to contact an attorney now.

[1] See Independent Contractor or Employee? (Parts 1, 3 and 4) blog articles for more information.

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