Int roduct ion and Review of W orker Classificat ion Issues: Independent Contractors vs. Employees

Transcription

1 Int roduct ion and Review of W orker Classificat ion Issues: Independent Contractors vs. Employees Paul La Monaca, CPA, MST Director of Education National Society of Tax Professionals 2016 National Society of Tax Professionals

2 A. Collection of Income Tax at Source of Wages Internal Revenue Code, Chapter 24, Subchapter A, addresses issue of withholding from wages addresses definitions. 3401(a) provides that wages means all remuneration, (other than fees paid to a public official), for services performed by an employee for employer and includes cash value of benefits. 3401(a)(1)-(23) lists exceptions to the term wages. 3401(c) defines the term employee. 3401(d) defines the term employer.

3 B Income Tax Collected at Source 3402(a)(1) provides that employers who pay wages shall deduct and withhold taxes. 3402(a)(2) provides for purpose of applying tables or procedures it is based on the amount of wages and number of exemptions claimed under 151(b). 3402(c) provides that withholding can be done according to wage bracket. 3402(d)(2) addresses the issue of tax paid by the recipient, but not deducted and withheld by employer addresses the issue of liability for the tax and provides that the employer shall be liable for the payment of the tax required to be deducted and withheld.

4 B Income Tax Collected at Source Subtitle C of the IRC addresses employment taxes in general; includes matching of FICA and Medicare, as well as the federal unemployment tax (FUTA) for employees. Law requires specific periods for submitting the taxes in the form of tax deposits. Under 3501, law requires periodic submission of payroll tax forms and reconciliation of the taxes collected and submitted with summation to Forms W-2 & W-3. U.S. tax system survives because of the withholding of tax at the source in which it is earned.

5 C Determination of Employer s Liability for Certain Employment Taxes 3509(a) provides a general rule for liability for employers who fail to deduct and withhold any tax under Chapter 24 of Subchapter A or Chapter 21. Federal Income Tax liability equal to 1.5% of wages Employee Social Security Tax liability equal to 20% of amount imposed 3509(b) provides that employer s liability be increased where employer disregards the reporting requirements. 3509(b)(1) provides a general rule for employers who don t meet the requirements of 6041(a), 6041A or 6051 with respect to any employee, unless failure is due to reasonable cause and not willful neglect. 3509(b)(2) provides that applicable requirements means the requirements which would be applicable consistent with the employer s treatment of the employee not being an employee for purposes of income tax or payroll tax withholding and matching.

6 Tax Professional Education Fact 6041(a) addresses the issue of providing a statement to the recipient who is paid $600 or more, requiring the issuance of IRS Form MISC. 6041A addresses the issue of returns for payments of remuneration for services and direct sales and 6051 deals with receipts for employees if there is any withholding of taxes by an employer.

7 D Individuals Providing Companion Sitting Placement Services 3506(a) provides a general rule regarding persons who are in the business of putting sitters in touch with individuals who wish to employ them to not be treated as employers under certain conditions. 3506(b) defines the term sitters to mean those who furnish personal attendance companionship, or household care services to children or to individuals who are elderly or disabled. 3506(c) provides that the Secretary shall provide regulations as needed to carry out the purpose of this section.

8 E Treatment of Real Estate Agents & Direct Sellers 3508(a) provides a general rule regarding services performed as a qualified real estate agent or direct seller: a) Individual performing services shall not be treated as an employee. b) Person for whom services are performed shall not be treated as an employer. 3508(b)(1) defines qualified real estate agent to mean any individual who is a sales person if: a) Such individual is a licensed real estate agent; b) Substantially all of the remuneration for services performed is directly related to sales or other output rather than to number of hours worked, and c) Services performed by individual are performed pursuant to a written contract between such individual and the person for whom the services are performed and contract provides the individual will not be treated as an employee with respect to such services for federal tax purposes.

9 E Treatment of Real Estate Agents & Direct Sellers 3508(b)(2)(A) defines direct seller to mean any person if such person: a) Is engaged in the trade or business of selling (or soliciting the sale of) consumer products to any buyer on a buy-sell basis, a deposit-commission basis, or similar basis, for resale in the home or otherwise than in a permanent retail establishment. b) Is engaged in the trade or business of selling (or soliciting the sale of) consumer products in the home or otherwise than in a permanent retail establishment. c) Is engaged in the trade or business of the delivering or distribution of newspapers or shopping news. For purposes of defining a direct seller 3508(b)(2) provides that substantially all remuneration (cash or not) for performance of services described in subparagraph (a) is directly related to sales or other output, rather than number of hours worked.

10 3508 Treat ment of Real Estate Agents and Direct Sellers 3508(b)(2) also provides that services are performed pursuant to a written contract between such person and the person for whom the services are performed and such contract provides that the person will not be treated as an employee for federal tax purposes. 3508(b)(3) provides coordination with retirement plans for self-employed. This section shall not apply for purposes of subtitle A to the extent that the individual is treated as an employee under 401(c)(1) (relating to self-employed individuals).

11 F. Independent Contractor vs. Employee: Independent Contractor Defined Reg (c)-1(b) states that for the purpose of withholding taxes a worker who is subject to the control and direction of another only as to the result of his work, and not as to the means, is an independent contractor and not an employee. In the same regulations the Service states that a freelance worker whose boss has the right to tell him what kind of work to do and how to do it is considered an employee. Reg (c)-1(c) states that physicians, lawyers, dentists, veterinarians, contractors, subcontractors, public stenographers, auctioneer and others who follow an independent trade, business or profession in which they offer their services to the public are usually considered independent contractors. Revenue Ruling states that a person who works at home on a piecework basis is considered an independent contractor if he is subject to another s control only as to the result of the services and not the method.

12 F. Independent Contractor vs. Employee: Independent Contractor Defined A worker can strengthen the position of being an independent contractor by performing the following actions: a) Register with the local jurisdiction to do business in the city, county or location where the business is performing its activities. b) Advertise their services to show a desire to grow and expand. c) Register with and join the Better Business Bureau. d) Obtain a contract from the provider of work which specifies that the relationship is one of independent action. e) Obtain a federal EIN and give the operation a business name.

13 F. Independent Contractor vs. Employee: Independent Contractor Defined f) Consider forming a Limited Liability Company (LLC). g) Open a business checking account, and separate credit card for business purposes only. h) Create logo, stationary, business cards, and website. i) Join an association that supports the goals of your industry, and participate in association activities. j) Purchase professional liability insurance such as errors and omissions coverage. k) Most importantly keep accurate books and records.

14 G. Employee vs. Independent Contractor: 20 Factor Common Law Control Test; 3 Categories of Evidence Rev. Ruling 87-41, CB 296, issued in 1987 by the IRS, helps workers and providers of work determine whether a worker is an employee or independent contractor for purposes of withholding federal taxes on wages. The Service developed a twenty-factor control test based on common law principles. The 20 factors indicate what degree of control by business over the worker is sufficient to establish an employer-employee relationship. Degree of importance of each factor varies depending on the occupation and factual context in which services are performed. The 20 factors are designed only as guides. Since 1990 s, IRS has viewed the issue of independent contractors by focusing on the issue of control under categories of evidence. IRS Letter Ruling lists the categories of evidence as follows: Behavioral control Financial control Type of relationship of the parties

15 Category of Evidence: Behavioral Control Behavioral control has been defined by the IRS as control or right to control what a worker does, and how it is done. Behavioral control looks at: a) Type of instruction given b) Degree of instruction given c) Evaluation systems of the work performed d) Training provided by the business Tax Professional Alert: If the worker provides their own methods, then it leans heavily to an independent contractor relationship. If the measuring is the end result by the worker, then an independent contractor relationship is indicated.

16 Category of Evidence: Financial Control Financial control focuses on the facts regarding a right to direct or control the financial business aspects of the worker s activities such as: a) Significant investment by worker and risk for loss or gain b) How worker is paid c) Expense reimbursements d) Providing of tools and supplies e) Services available to the relevant market in addition to the current service recipient 16

17 Category of Evidence: Type of Relationship Type of relationship is reviewed by the Service as to: a) Written contracts between the parties and action with respect to each other b) Employee-type benefits given to worker c) Worker s role as a key aspect of the business operations d) Permanency of the relationship e) How the parties represent their relationship to others

18 Category of Evidence: Type of Relationship If the provider of work cannot make a determination of the status of the worker, then IRS Form SS-8 could be filed. Misclassified workers can file IRS Form 8919 and report only their share of Social Security and Medicare.

19 H. 530 Relief: The Safe Harbor Rule A business can decide on the classification of workers based on its needs. If IRS rules that workers have been misclassified, then employer can seek 530 Relief under the 1978 Tax Reform Act from federal employment tax obligations. The Safe Harbor rule minimizes the uncertainty of taxpayers concerning proper classification of certain workers as employees or independent contractors for employment tax purposes. 530 Relief states that three requirements be met: Reporting consistency Substantive consistency, and Reasonable basis Reporting consistency: All federal returns, including information returns, required to be filed by the provider of work must be consistent. Substantive consistency: Provider of work did not treat any worker providing a substantially similar position or function as an employee for employment tax purposes while treating another as an independent contractor.

20 H. 530 Relief: Reasonable Basis Reasonable basis: A provider of work will be considered to have a safe harbor based on any of the following provisions of 530(a)(2) of the 1978 Tax Reform Act: a) Judicial precedent, published rulings, technical advice to the employer, or a letter ruling to the employer; b) Past examination of the employer by the IRS in which there was no assessment attributable to the treatment for employment tax purposes of individuals holding positions substantially similar to the position held by another individual; or c) Long-standing recognized practice of a significant segment of the industry in which the individual was engaged.

21 H. 530 Relief: Reasonable Basis Judicial or administrative rulings: The safe harbor is met if the provider of work relies on one of the specified authorities. Prior audit or examination: A taxpayer will be deemed to meet the reasonable basis requirement if the taxpayer can show reasonable reliance on a past IRS audit (which need not have involved employment taxes if the audit began before 1997) in which there was no assessment attributable to the taxpayer s treatment, as employees for employment tax purposes, of individuals holding positions substantially similar to the position of the individual in question.

22 H. 530 Relief: Reasonable Basis In the case of an audit beginning after 1996, the audit must include an examination of whether the worker involved should be treated as an employee for employment tax purposes. A compliance interview is not considered an audit. Audits conducted by agencies other than the IRS generally will not qualify a taxpayer for relief under the prior-audit safe harbor. Industry practice rule: Requires the employer to reasonably rely on a longstanding recognized practice of a significant segment of the industry in which the employee was engaged.

23 H. 530 Relief: Industry Practice Rule The Small Business Job Protection Act (1996) made two modification to the industry practice safe harbor: a) Industry safe harbor does not require a reasonable showing of the practice of more than 25 % of an industry. A lower percentage may constitute a significant segment of the taxpayer s industry based on the particular facts and circumstances. b) An industry practice need not have continued for more than 10 years in order to be considered long standing; a shorter period may be considered long-standing based on the facts and circumstances.

24 I. 20 Fact or Classifications The 20 factors are classified as follows: 1) Instructions to worker: A person who is required to comply with instructions about when, where and how to work is ordinarily an employee. 2) Training: Training by an experienced employee is a factor of control because it is an indication that the employer wants the services performed in a particular method or manner. 3) Integration into business operations: Integration of the person s services in the business operation generally shows that the person is subject to direction and control.

25 I. 20 Fact or Classifications 4) Requirement that services be rendered personally: If the services must be rendered personally, it indicates that the employer is interested in methods as well as results. 5) Hiring, supervising, and paying assistants: Hiring, supervising and paying of assistants by the employer generally shows control over all of the workers on the job. 6) Continuity of the relationship: The existence of a continuing relationship between an individual and the person for whom he performs services is a factor

26 I. 20 Fact or Classifications 7) Setting the hours of work: The establishment of set hours of work by the employer is a factor indicative of control. 8) Requirement of full-time work: If the worker is required to devote full time to the business of the employer, it is implicit that the worker is restricted from doing other gainful work, whereas an independent contractor may choose for whom and when to work. 9) Working on employer premises: Doing the work on the employer s premises implies that the employer has control. 10) Setting the order or sequence of work: If the person must perform services in the order or sequence set by the employer, it shows that the worker may be subject to control, although the fact that the employer retains the right to order the work may also show control.

27 I. 20 Fact or Classifications 11) Requiring oral or written reports: If regular oral or written reports must be submitted to the employer, it indicates control. 12) Paying worker by the hour, week, or month: An employee is usually paid by the hour, week, or month; payment on a job basis is customary when the worker is an independent contractor. 13) Payment of worker s business and/or traveling expenses: Payment by the employer of the worker s business or traveling expenses is a factor indicating control. 14) Furnishing worker s tools and materials: The furnishing of tools, materials, etc., by the employer is indicative of control.

28 I. 20 Fact or Classifications 15) Significant investment by worker: A significant investment by a worker in facilities he uses in performing services for someone else tends to show independent status, while the furnishing of all facilities by the employer tends to indicate employee status. 16) Realization of profit or loss by worker: People who are in a position to realize a profit or suffer a loss as a result of their services are generally independent contractors. 17) Working for more than one business at a time: If a person works for a number of employers or firms at the same time, it usually indicates an independent status.

29 I. 20 Fact or Classifications 18) Availability of worker s services to the general public: Workers who make their services available to the general public are usually independent contractors. 19) Firm s right to discharge worker: The right to discharge is an important factor indicating that the person possessing the right is an employer. 20) Worker s right to terminate relationship: An employee has the right to end the relationship with an employer at anytime the employee wishes without incurring liability, as distinguished from independent contractors, who usually agree to complete a specific job.

30 I. 20 Factor Classificat ions: Not es The IRS will rule on the status of a worker at the request of the worker or the employer. There is no private right of action under FICA to sue an employer for failure to withhold and pay FICA taxes when the employer treats the workers as independent contractors and the workers feel they should be treated as employees. A bankruptcy court has stated that the IRS s 20 Factor test was not all-inclusive and considered an additional four factors: The industry practice or custom in the area of the parties. The intent of the parties. Whether written, signed independents contractor agreements were executed. Whether employee-type benefits were provided.

31 20 Factor Classificat ions: Example Example: Instructions to workers Example: Training Examples: Taxpayers ruled to be independent contractors Nurses were independent contractors, not agency employees Nurses working through nurse s registry were independent contractors Examples: Taxpayers ruled to be employees Newspaper assembler is an employee College professor is an employee Office manager and secretary are employees

32 N. Trades or Business Ruled to be Taxed for Self- Employment: Independent Contractors The following individuals have been determined to be in trades or businesses giving rise to self-employment income: Individuals who carry on the professional practice of medicine, dentistry, etc. on their own. Physician serving as local surgeons for a railway company An individual performing part-time services such as bookkeeping on the premises for a corporation at hours of his choosing; accountants who make their services available to the general public An attorney engaged by a corporation and paid an annual retainer An author who received royalty income from writing books and preparing new editions of some books over a period of a year.

33 N. Trades or Business Ruled to be Taxed for Self- Employment: Independent Contractors A resident alien author who received royalties for books published while the author was a nonresident alien. A university professor who received royalties from writing books and income from lectures that weren t part of his university duties. An individual who operated an automobile body repair shop located in space furnished by an automobile sales agency. An individual who performed services as a qualified direct seller. A handyman who received income from performing various odd jobs including repairing household items, performing yard maintenance, and shoveling snow.

34 N. Trades or Business Ruled to be Taxed for Self- Employment: Independent Contractors Bonding agents who performed services for a bonding company and who were found not to be employees of the company. An individual serving as a federal armory custodian under contract. An individual who is paid for making speeches. Individuals conducting surveys as part of a corporation s advertising campaign when the corporation is interested only in results of the survey. A money-lending activity when services were provided to individuals on a regular and continuous basis and with expectation of profit. An individual who installs refrigeration equipment under separate contracts with various clients.

35 N. Trades or Business Ruled to be Taxed for Self- Employment: Independent Contractors Individuals engaged as qualified real estate agents. A manicurist performing services in a barber shop, who chooses her customers, regulates her working hours, supplies her own equipment and supplies, and retains the proceeds from her service. A seamstress for an established clientele who performs services in customers home, furnishes the required equipment and determines the fees to be charged. An individual who received telephone orders for both the sale and rental of portable advertising signs.

36 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates Ruling that a taxpayer was entitled to 530 employment-tax relief even though it failed to timely file some information returns dealing with workers it treated as independent contractors. A. Background 1. Independent contractor or employee status generally determined with reference to a number of common-law factors of the 1978 Revenue Act provides retroactive and prospective relief from employment tax liability for employers who misclassified workers as independent contractors using the common-law facts and circumstances standards.

37 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates applies only if: a) Taxpayer does not treat an individual as an employee for any period and does not treat any individual holding a substantially similar position as an employee for purposes of employment tax for any period, b) For post-1978 periods, federal returns must be consistent with the taxpayer s treatment of the individual as a non-employee, and c) Taxpayer had a reasonable basis for not treating the worker as an employee.

38 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates B. Facts 1) Medical Emergency Care Associates, relying on a long-standing, recognized practice of its industry, treated as independent contractors 25 doctors with whom it contracted for services. 2) It didn t treat them as employees for any period. Form 1096 and Forms 1099 MISC were filed late. 3) The lateness was caused in part by a death in the family of Medical s sole owner, and in part by an accountant s incorrect Form 1099 entries.

39 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates B. Facts 4) IRS said it didn t receive the late-filed forms; Medical filed again. 5) The late-filed forms were completed in a manner consistent with Medical s characterization of the doctors as independent contractors. 6) IRS agreed that Medical met the 1 st and 3 rd conditions above, but maintained that it failed the second (reporting consistency) requirement because the 1996 Form 1096 and some of the Forms 1099 were filed late.

40 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates B. Facts 7) As a result, IRS said Medical didn t qualify for 530 relief and the doctors were its employees, not independent contractors. 8) IRS argued this before the Tax Court, and emphasized the fact that the returns were not filed timely. 9) Rev. Proc , CE 518 specifically states that 530 relief won t be granted if Form 1099 has not been timely filed for each worker for any post-1978 period. 10) Given Congress intensive scrutiny of 530 and the way IRS interpreted it, the reporting consistency requirement would have been amended if Congress disagreed with Rev. Proc

41 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates C. Reporting consistency met despite late filing 1) The Tax Court ruled that Medical met the reporting consistency requirement despite its late filing of information returns. 2) It stated there is nothing in the language of the provision requiring timeliness along with consistent filing, nor was there legislative history to indicate that denial of 530 relief was meant to be an additional penalty for failure to timely file the necessary information returns, particularly under the circumstances of the case. 3) The Tax Court acknowledged that the IRS s interpretation of a statute was entitled to some deference.

42 O. 530 Employment Tax Relief: Late Filed Forms 1099 M ISC: M edical Emergency Care Associates C. Reporting consistency met despite late filing 4) The Tax Court also acknowledged the Rev. Proc was cited by a court for its requirement of timely filing. 5) However, the Tax Court said that because Rev. Proc didn t explain why timely filing was required, it wasn t able to ascertain the thoroughness of IRS s consideration or the validity of its reasoning. 6) As a result, the Tax Court said it would not defer to IRS s timely-filing requirement.

43 P. Determining Whether Worker Treated as an Employee for Any Period 1. The IRS provides the following guidelines for use in determining whether an employer treated an individual as an employee for any period, the threshold of 530 of P>L> (Rev. Proc ). a) The withholding of income tax or FICA tax from an individual s compensation (other than from a statutory employee) is treatment of the individual as an employee, whether or not the tax is remitted to the government. b) Except as provided below, the filing of an employment tax return for any period with respect to an individual, whether or not tax was withheld from the individual, is treatment of the individual as an employee for that period.

44 P. Determining Whether Worker Treated as an Employee for Any Period c) The filing of a delinquent or amended employment tax return for a particular tax period on an individual as a result of IRS compliance procedures is not treatment of the individual as an employee for that period. d) Service center notices that merely advise the taxpayer that no return has been filed and request information from the employer are not compliance procedures. e) A return prepared by the IRS is not treatment of an individual as an employee, nor is the signing of an audit Form 2504, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment.

45 P. Determining Whether Worker Treated as an Employee for Any Period 1. A taxpayer also does not satisfy the safe harbor rules if it treats certain workers as employees and others as independent contractors when the two groups hold substantially similar positions. 2. Similarly, a nail salon that erroneously treated some of its manicurists as independent contractors, and therefore failed to pay employment taxes, was not entitled to the benefits of the safe harbor provision under 530 because it did not consistently treat all of its manicurists as independent contractors.

46 Q. Form 8919: Actions Available to Workers For the worker who has been unilaterally treated as an independent contractor and the worker feels that they should have been classified as an employee, there can be a request for relief by filing IRS Form 8919, Uncollected Social Security and Medicare Tax on Wages. By filing Form 8919, the worker can be relieved of the matching of the Social Security and Medicare taxes and only pay the employee s share of those taxes.

47 Q. Form 8919: Actions Available to Workers In order to receive relief the taxpayer must file Form 8919 if ALL of the following apply: They performed services for a firm, The firm did not withhold the worker s share of social security and Medicare taxes, The compensation from the firm was not for services as an independent contractor, One or more of the following reasons apply to the taxpayer s situation: 1. They have filed and received a determination letter stating that they are an employee of this firm.

48 Q. Form 8919: Actions Available to Workers Cont. One or more of the following reasons apply to the taxpayer s situation: 2. They were designated as a 530 employee prior to January 1, 1997, 3. They received other correspondence from IRS stating that they are an employee, 4. They were previously treated as an employee by this firm and are performing services in a substantially similar direction and control, Note: They must also submit IRS Form SS Their co-workers, performing substantially similar services under substantially similar direction and control, are treated as employees. 6. Note: They must also submit IRS Form SS Taxpayer has already filed Form SS-8 with the IRS and has not received a reply.

49 Q. Form 8919: Actions Available to Workers The result of filing Form 8919 is that it allows the taxpayer to calculate and report their share of Social Security and Medicare taxes on their compensation as if they were in fact an employee.