Is Your Worker an Employee or Contractor: The Tax Rules
Is your worker an employee or a contractor? This is a frequent dispute between taxpayers and the IRS. Misclassified employees can result in significant penalties and interest. Here is what the employer needs to know about the employee vs. independent contractor rules.
About Employment TaxesThere are two taxes that, collectively, are commonly referred to as *employment taxes.* This includes taxes levied under the Federal Insurance Contributions Act (FICA) and unemployment taxes levied under the Federal Unemployment Tax Act (FUTA).
FICA is paid by the employer and employee. FUTA is paid by the employer.
While not an employment tax, employers also have to withhold income taxes on wages paid to employees.
This withholding obligation only applies to employees, not independent contractors.
Who is an Employee for Employment Tax?For employment taxes, an employee includes *any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee." What does this mean?
The *common law rules* consist of a number of factors established by the courts. These factors include:
1. The degree of control exercised by the person for whom the work is performed over the details of the work.
2. Which party invests in the facilities used by the worker.
3. The opportunity of the worker for profit or the risk of the worker for loss.
4. Whether the principal has the right to discharge the worker.
5. Whether the work is part of the principal's regular business.
6. The permanency of the relationship between the principal and the worker.
7. The relationship that the principal and the worker believed they were creating.
8. Whether the principal provided the worker any so-called employee benefits.
Each factor is to be considered in determining whether an individual is an employee.
The Critical Control FactorWhile no factor is determinative, the courts have accorded the first factor the most weight. This factor looks to the degree of control the employer has over the worker.
The courts have said that the employer does not need to stand over the worker and direct their every move. It is sufficient that they have the right to do so.
The right to discharge is also an important factor indicating that the person possessing that right is an employer.
Control also does not necessarily come from being able to establish the hours of the worker or supervise every detail of that worker's work environment. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work to the individual who performs the services.
Many of the cases where the worker was not found to be an employee due to the lack of control, the courts relied on this concept: *if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is not an employee.*
How Much Control Is Required?How much control is required to be an employee varies by the nature of the work involved. When the nature of the work is more independent, a lesser degree of control by the person for whom the services are performed may still result in a finding of an employer and employee relationship.