Independent Contractors v. Employees and Why It Matters By Barbara G. Stephenson Employment Law Client Breakfast Program July 7, 2010 Disclaimer The authors, publishers, speakers, and sponsors of this program present these materials with the understanding that the information provided is not legal advice. Due to the rapidly changing nature of the law, information contained in these publications or presented by the speakers may become outdated. As a result, an attorney or other individual using these materials must always research original sources of authority and update this information to ensure accuracy when dealing with a specific client s legal matters. Further, the presentation or materials provided are not intended to establish practice standards or standards of care applicable to an attorney s performance. In no event will the authors, the sponsors, the speakers, or the publishers be liable for any direct, indirect, or consequential damages resulting from the use of these materials.
Independent Contractors v. Employees and Why It Matters By Barbara G. Stephenson I. Overview Employers may be tempted to classify workers as independent contractors for administrative convenience or to avoid having to pay payroll taxes, overtime, etc. Further temptations are presented to employers because employers do not have to cover independent contractors under workers compensation or unemployment compensation insurance. The penalties and potential liabilities for misclassification are very significant. Consequently, employers should be careful before designating any worker as an independent contractor. Neither the fact that a worker has signed a document agreeing to be an independent contractor nor the longevity of a relationship should be determinative. In any event, the worker s consent to an unlawful arrangement will not be valid. At all times, the facts characterizing the actual relationship will be what counts. a. IRS Independent Contractor Test Prior to 2006, the IRS used what was known as the Twenty Factor Test to determine if a worker was an independent contractor or an employee. The Twenty Factor Test included such factors as degree of business integration (how much the worker s services were integrated into business operations), whether the worker s schedule was flexible, and whether the worker simultaneously could provide services to other unrelated companies. A worker did not have to meet all 20 criteria to qualify as an employee or independent contractor and no single factor was decisive in determining status.
Because some members of Congress and representatives of labor and business considered the Twenty Factor Test too complicated, the IRS issued a simplified test in January, 2006. The 20 factors were consolidated into 11 main tests and organized into three groups of behavioral control, financial control, and the type of relationship between the worker and the company. Appendix D, from the IRS, attached as Exhibit 1, sets out these three groups of criteria. Companies still must weigh all of the factors when classifying a worker. Some factors may indicate that the worker is an employee while others indicate the worker is an independent contractor. The IRS has noted that there is no magic number of factors that determines a worker s status. In addition, no one factor is determinative and factors which are relevant in one situation may not be relevant in another. While the new tests are viewed as placing more emphasis on the key factor of control, be it behavioral or financial, the process is not considered to have been simplified to any significant degree. b. Use of a Form SS-8 If the worker or company remains unclear as to whether there is an employment or independent contractor relationship, either can ask for an IRS determination of the status of a worker for purposes of federal employment taxes and income tax withholding by filing a Form SS-8. See attached Exhibit 2. No determination will be issued for a tax year for which the statute of limitations on the tax return has expired. Where the worker has initiated the process, the IRS will send the company a request to complete a Form SS-8. The IRS cautions that a determination can take at least six months. The IRS decision is binding on the affected worker (or class of workers), the company, and the IRS.
c. Penalties for Misclassification of Workers It is the opinion of some employer groups that the federal government soon will increase its efforts to identify misclassified workers in order to reduce lost payroll tax revenues. President Obama s 2011 budget proposal includes an additional $25 million to target misclassification of employees with 100 additional enforcement personnel. The IRS already is initiating worker classification audits of businesses. Penalties for misclassification of workers are significant. Even if an independent contractor already has paid selfemployment tax on income, the employer will have to pay that amount again based on the gross amount paid and not the net income of the contractor. The liability for an employer that unintentionally misclassified an employee is limited to 1.5% of the employee s wages for income tax withholding and 20% of the employee s portion of the FICA tax. Intentionally misclassifying a worker exposes the employer to more severe penalties. Possible actions can include the full amount of income tax that should have been withheld, the full amount of the employer s and employee s FICA payments, interest and penalty amounts, and possible civil and criminal penalties including possible jail time. After the IRS has assessed taxes and penalties, the agency likely will send the employer s file to the New Mexico Department of Workforce Solutions. That agency will then seek unpaid employment taxes thus adding to the employer s expenses.
Jlpendix D - IRS Independent Contractor Test http://www.twc.state.tx.us/news/efte/appx_d_irs_ ic_test.htrr PDF files require Adobe Acrobat Reader for viewing. ( Tabfe of Contents 'f Index ~~, Top Ten Tips Disclaimer Appendix D - IRS Independent Contractor Test APPENDIX D INDEPENDENT CONTRACTOR TEST INTERNAL REVENUE SERVICE IRS Independent Contractor Test The IRS formerly used what has become known as the "Twenty Factor" test. Under pressure from Congress and from representatives of labor and business, it has recently attempted to simplify and refine the test, consolidating the twenty factors into eleven main tests, and organizing them into three main groups: behavioral control, financial control, and the type of relationship of the parties. Those factors appear below, along with comments regarding each one (source: IRS Publication 15-A, 2010 Edition, page 6; available for downloading from http://www.irs.gov/pub/irs-pdf/p15a.pdf (PDF). Another good IRS resource for understanding the independent contractor tests is at http://\iv\nw.irs.govlbusinesses /small/article/o"id=99921,00.htm!. Behavioral control Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of- 1. Instructions the business gives the worker. An employee is generally subject to the business' instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work:. a. When and where to do the work b. What tools or equipment to use c. What workers to hire or to assist with the work d. Where t6 purchase supplies and services e. What work must be performed by a specified individual f. What order or sequence to follow EXHIBIT The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right. 2. Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods. Financial control Facts that show whether the business has a right to control the business aspects of the worker's job include: 3. The extent to which the worker has unreimbursed business expenses. Independent contractors are more
ji)pendix 0 - IRS Independent Contractor Test http://www.twc.state.tx.us/news/efte/appx_d_irs_ic_test.htrn likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their business. 4. The extent ofthe workers investment. An employee usually has no investment in the work other than his or her own time. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status. 5. The extent to which the worker makes services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market. 6. How the business pays the worker. An employee is generally guaranteed a regularwage amount for an hourly, weekly, or other periodof time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly. 7. The extent to which the worker can realize a profit or loss. Since an employer usually provides employees a workplace, tools, materials, equipment, and supplies neede9 for the work, and generally pays the costs of doing business, employees do not have an opportunity to make a profit or loss. An independent contractor can make a profit or loss. Type of relationship Facts that show the parties' type of relationship include: 8. Written contracts describing the relationship the parties intended to create. This is probably the least important of the criteria, since what really matters is the nature of the underlying work relationship, not what the parties choose to call it. However, in close cases, the written contract can make a difference. 9. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. The power to grant benefits carries with it the power to take them away, which is a power generally exercised by employers over employees. A true independent contractor will finance his or her own benefits out of the overall profits of the enterprise. 10. The permanency ofthe relationship. If the company engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship. 11. The extent to which services performed by the worker are a key aspect ofthe regular business ofthe company. If a worker provides services that are a key aspect of the company's regular business activity, it is more likely that the company will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship. Former IRS Twenty-Factor Test The previous twenty-factor test used by the IRS can be seen in the test (see Appendix E of this article) officially adopted by the Texas Workforce Commission: the agency which enforces the state unemployment tax in Texas. That test may be found on the Internet at http://www.texasworkforce.org/ui/taxlforms/c8.pdf (PDF). Employers may also request a copy in printed form by asking for Form C-8 from "Texas Workforce Commission, Tax Department, 101 E. 15th Street, Austin, Texas, 78778". Do not underestimate the difficulty of applying these standards to specific individuals performing services. In doubtful cases, always consult a knowledgeable labor and employment law attorney. Return to Businesses & Employers Return to TWC Home
Form 88 8 (Rev. December 2009) Department of the Treasury Internal Revenue Service Name of firm (or person) for whom the worker performed services Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding Worker's name OMS No. 1545-0004 Firm's address Qnclude street address, apt. or suite no., city, state, and ZIP code) Worker's address Qnclude street address, apt. or suite no., city, state, and ZIP code) Trade name Daytime telephone number IWorker's ;social secu;rity number Telephone number Qnclude area code) I Firm's emp;oyer identification number Worker's employer identification number (if any) Note. If the worker is paid by a firm other than the one listed on this form for these services, enter the name, address, and employer identification number of the payer. ~ Disclosure of Information. the information provided on Form 88-8 may be disclosed to the firm, worker, or payer named above to assist the IRS in the determination process. For example, if you are a worker, we may disclose the information you provide on Form 8S-8 to the firm or payer named above. The information can only be disclosed to assist with the determination process. If you provide incomplete information, we may not be able to process your request. 8ee Privacy Act and Paperwork Reduction Acf Notice on page 5 for more information. If you do not want this information disclosed to other parties, do not file Form 55-8. Parts I-V. All filers of Form 8S-8 must complete all questions in Parts I-IV. Part V must be completed if the worker provides a service directly to customers or is a salesperson. If you cannot answer a question, enter "Unknown" or "Does not apply." If you need more space for a question, attach another sheet with the part and question number clearly identified. ImI General Information This form is being completed by: o Firm 0 Worker; for services performed ---;;---,--,_-;-;-;- to --,_::---:--:-: _ {beginning date) (ending date) 2 Explain your reason(s) for filing this form (for example, you received a bill from the IRS, you believe you erroneously received a Form 1099 or Form W-2, you are unable to get worker's compensation benefits, or you were audited or are being audited by the IRS)..... _. _ 3 Total number of workers who performed or are performing the same or similar services _ 4 How did the worker obtain the job? 0 Application 0 Bid 0 Employment Agency 0 Other (specify) 5 Attach copies of all supporting documentation (contracts, invoices, memos, Forms W-2 or Forms 1099-MISC issued or received, IRS closing agreements, IRS' rulings, etc.)_ In addition, please inform us of any current or past litigation concerning the worker's status. If no income reporting forms (Form 1099-M18C or W-2) were furnished to the worker, enter the amount of income earned for the year(s) at issue $ _ If both Form W-2 and Form 1099-MISC were issued or received, explain why.... _ 6 Describe the firm's business....... _..... ~.. _.._.._ 7 Describe the work done by the worker and provide the worker's job title...... _ EXHIBIT --- --- ---.- _. -- _ --._---. ---- -.----.-._- --- --.., ----- -- --- ---- -- -- -- ------. _.._..------- ------ --_. --- --- ----- ~ 1i 1> --- --. ------ --- ---- -- - -- - - -... ----"- --- ----- -.-- --- ---- -- - ---- - - - - --- - ---- - -- - - - -- --..-- - -- -- - - -.- -. -- - -- --- 19 8 Explain why you believe the worker is an employee or an independent contractor... --_._-------------------------------------...-----------.--- _._------------------------------------_..-------_._----'----" 9 Did the worker perform services for the firm in any capacity before providing the services that are the subject of this determination request? DYes 0 No 0 N/A If "Yes," what were the dates of the prior service?............. _.. _.. If "Yes," explain the differences, if any, between the current and prior service............ 10 If the work is done under a written agreement between the firm and the worker, attach a copy (preferably signed by both parties). Describe the terms and conditions of the work arrangement.... _... _........ _. _ For Privacy Act and Paperwork Reduction Act Notice, see page 5. Cat. No. 16106T Form 55-8 (Rev. 12-2009)
Form 55-8 (Rev. 12-2009) Page 2 la,1 Behavioral Control What specific training and/or instruction is the worker given by the firm? 2 How does the worker receive work assignments?._._...._........._. 3 Who determines the methods by which the assignments are periormed? _....... _._._....._....... 4 Who is the worker required to contact if problems or complaints arise and who is responsible for their resolution?.. _...._ 5 What types of reports are required from the worker? Attach examples.._..... _........_..._.._ 6 Describe the worker's daily routine such as, schedule, hours, etc..... _..._.........._..._ _. 7 At what location(s) does the worker periorm services (e.g., firm's premises, own shop or office, home, customer's location, etc.)? Indicate the appropriate percentage of time the worker spends in each location, if more than one.._...... _.... 8 Describe any meetings the worker is required to attend and any penalties for not attending (e.g., sales meetings, monthly meetings, staff meetings, etc.)..... _._. _..........._........ _._.. 9 Is the worker required to provide the services personally? 0 Yes 0 No 10 If substitutes or helpers are needed, who hires them? _.._... _....._.... _.._.. _...._..... 11 If the worker hires the substitutes or helpers, is approval required? 0 Yes 0 No If "Yes," by whom?............. _.. _..... _... _... _.. _._... _... _.. 12 Who pays the substitutes or helpers?... "....._....... _.. _. _....._.. 13 Is the worker reimbursed if the worker pays the substitutes or helpers? 0 Yes 0 No If "Yes," by whom? mlill Financial Control List the supplies, equipment, materials, and property provided by each party: The finn............_... _......._.... _" _ The worker..........................._.. _._. Other party........ _........ _.......,... 2 Does the worker lease equipment?. 0 Yes 0 No If "Yes," what are the terms of the lease? (Attach a copy or explanatory statement.) _... _.._........ _ 3 What expenses are incurred by the worker in the perionnance of services for the firm?. _.... _...... _ 4 Specify which, if any, expenses are reimbursed by: The firm... _...... _..... _..... _..... Other party. _.. _........ _........ _........... c _ 5 Type of pay the worker receives: 0 Salary 0 Commission 0 Hourly Wage 0 Piece Work o Lump Sum 0 Other (specify)..._.........._.. _ If type of pay is commission, and the firm guarantees a minimum amount of pay, specify amount $ 6 Is the worker allowed a drawing account for advances?. 0 Yes 0 No If "Yes," how often?... _._..... _. _............_..... Specify any restrictions.... _...... _...... _............. _... _. 7 Whom does the customer pay?. If worker, does the worker pay the total amount to the firm? 0 Yes o Firm 0 Worker o No If "No," explain. _....... _ 8 Does the firm carry worker's compensation insurance on the worker? 0 Yes 0 No 9 What economic loss or financial risk, if any, can the worker incur beyond the normal loss of salary (e.g., loss or damage of equipment, material, etc_)?..... _... _.... _...... ~.......... Form 55-8 (Rev. 12-2009)
Form SS-8 (Rev. 12-2009) liltiicj Relationship of the Worker and Firm Page 3 List the benefits available to the worker (e.g., paid vacations, sick pay, pensions, bonuses, paid holidays, personal days, insurance benefits)............ _. _...._..... _. _.. _..... _. _.. _ 2 Can the relationship be terminated by either party without incurring liability or penalty? 0 Yes 0 No If "No," explain your answer.... _._.._.. _............. _.._. 3 Did the worker perform similar services for others during the same time period? 0 Yes 0 No If "Yes, n is the worker required to get approval from the firm?. 0 Yes 0 No 4 Describe any agreements prohibiting competition between the worker and the firm while the worker is performing services or during any later period. Attach any available documentation............ _._......._.......... _. 5 Is the worker a member of a union? 0 Yes 0 No 6 What type of advertising, if any, does the worker do (e.g., a business listing in a directory, business cards, etc.)? Provide copies, if applicable. 7 If the worker assembles or processes a product at home, who provides the materials and instructions or pattern?....._. 8 What does the worker do with the finished product (e.g., return it to the firm, provide it to another party, or sell it)?....... _. _ 9 How does the firm represent the worker to its customers (e.g., employee, partner, representative, or contractor)?... _..... _.. 10 If the worker no longer performs services for the firm, how did the relationship end (e.g., worker quit or was fired, job completed, contract ended, firm or worker went out of business)?.. _..................,_. _._._..... _._.. IlfII!I For Service Providers or Salespersons. Complete this part if the worker provided a service directly to customers or is a salesperson. What are the worker's responsibilities in soliciting new customers?........... _..... _... _... 2 Who provides the worker with leads to prospective customers?... _......... _. ".. _...._... _..... _._. 3 Describe any reporting requirements pertaining to the leads... _. _. _.... _... _...... _.. _.. 4 What terms and conditions of sale, if any, are required by the firm?. _.... _....... 5 Are orders submitted to and subject to approval by the firm? 0 Yes 0 No 6 Who determines the worker's territory?... _.. _............ _....._ 7 Did the worker pay for the privilege of serving customers on the route or in the territory?. 0 Yes 0 No If "Yes," whom did the worker pay?........... _.... _.... _. _._._.. _.... _.. _....._ If Yes," how much did the worker pay? $ _ 8 Where does the worker sell the product (e_g., in a home, retail establishment, etc.)?._........_._._. _ 9 List the product and/or services distributed by the worker (e.g., meat, vegetables, fruit, bakery products, beverages, or laundry or dry cleaning services). If more than one type of product and/or service is distributed, specify the principal one....... _.. _...... 10 Does the worker sell life insurance full time? DYes 0 No 11 Does the worker sell other types of insurance for the firm?. DYes 0 No If "Yes," enter the percentage of the worker's total working time spent in selling other types of insurance % 12 If the worker solicits orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments, enter the percentage of the worker's time spent in the solicitation _ % 13 Is the merchandise purchased by the customers for resale or use in their business operations?. DYes 0 No Describe the merchandise and state whether it is equipment installed on the customers' premises.._........ _ Sign Here Under penalties of perjury, I declare that I have examined this request, including accompanying documents, and to the best of my knowledge and belief, the facts presented are true, correct, and complete. Type or print name below signature. Title Date Form SS-8 (Rev. 12-2009)