Taxpayers and businesses alike frequently find themselves in tax court over the question of whether a worker is an independent contractor or employee for federal income and employment tax purposes. Jane Scaccetti, a D&S partner, in fact, recently tweeted about just such a case, in which a taxpayer lost his case. The question can be quite complex and the stakes can be very high. Let’s try to shed some light, in this brief blog, on some of the more obvious ways to determine on which side a worker may fall and what employers should do to comply with the law.
If a worker is an employee, the company must withhold federal income and payroll taxes, pay the employer's share of FICA taxes on the wages plus FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well. These obligations don't apply for a worker who is an independent contractor. The business sends the independent contractor a Form 1099-MISC for the year showing what he or she was paid (if it amounts to $600 or more), and that's all. For truly independent contractors, the onus now falls on them to be compliant.
Who is an “employee?” Is there a real definition of the term? The answer is, “not really.”
Under the common-law rules (so-called because they originate from court cases rather than from a statute), an individual generally is an employee if the enterprise he or she works for has the right to control and direct him regarding the job he is to do and how he is to do it. Otherwise, he is an independent contractor. But the water here is murky as best and the lines are extremely gray. Hence, we see case after case ending up in tax court.
Some employers that have misclassified workers as independent contractors are relieved from employment tax liabilities under Section 530 of the 1978 Revenue Act (not the Internal Revenue Code). In brief, Section 530 protection applies only if the employer:
- filed all federal returns consistent with its treatment of a worker as an independent contractor;
- treated all similarly situated workers as independent contractors; and
- had a “reasonable basis” for not treating the worker as an employee.
For example, a “reasonable basis” exists if a significant segment of the employer's industry has traditionally treated similar workers as independent contractors. Section 530 doesn't apply to certain types of technical services workers.
Individuals who are “statutory employees,” (that is, specifically identified by the Internal Revenue Code as being employees) are treated as employees for social security tax purposes even if they are not subject to an employer's direction and control (that is, even if the individuals wouldn't be treated as employees under the common-law rules). These individuals are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Statutory employees may or may not be employees for non-FICA purposes. Corporate officers are statutory employees for all purposes.
Individuals who are statutory independent contractors (that is, specifically identified by the Internal Revenue Code as being non-employees) aren't employees for purposes of wage withholding, FICA, or FUTA and the income tax rules in general. These individuals are qualified real estate agents and certain direct sellers.
Some categories of individuals are subject to special rules because of their occupations or identities. For example, corporate directors aren't employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons.
Under certain circumstances, you can ask IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee.
As mentioned earlier, this can become a complex issue and if you find yourself in this situation, you should seek professional assistance. With all the changes in the tax laws it is more difficult than ever to definitely know whether you are a contractor or employee.
If you need to discuss with The Tax Warriors how these complex rules apply to you or your business, to help ensure that none of your workers are misclassified or that you don’ end up in tax court, please contact us by clicking “Ask A Tax Warrior” below or calling us at (215) 665-3960. At Drucker & Scaccetti, we are always prepared to help you with this or any other tax-related matter.