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Simplified Employee v Independent Contractor Rules


The IRS has historically used a 20-factor test to determine whether a worker is an employee or an independent contractor.  The common theme among the 20 factors is the degree of control the company who hired this worker has over them.

This has been a very hot audit area by the IRS for years.  Businesses have been able to avoid the IRS reclassifying independent contractors as employees by filing 1099’s as long as the Company has a reasonable basis for classifying them as a an independent contractor. Their position can be supported by facts such as reliance upon prior court cases or revenue rulings, a previous employment tax examination,  or standard industry practice.

President Obama has been trying to repeal the above relief but Congress has been reluctant to address this unless it is included with new tax reform legislation.

So what should businesses know about how to handle these workers?  Recently, the IRS has reduced the 20 factors into three categories for their audits:

  • Behavior
  • Financial
  • Type of relationship

The Behavioral Test
Does the Company control or have the right to control what the worker does and how the perform the work?  Key factors looked at are the type and degree of instructions give to the worker – the “who,what, when, where, and why”, the degree of training, and evaluation criteria.

The Financial Test
Who controls the economics of the worker’s job?  Key factors include reimbursement of expenses, who provides job-related tools and supplies, if the worker is paid hourly or by the piece, ability to work for more than one company, and opportunity to make a profit or incur a loss.

Type of Relationship Test
How do the parties perceive each other? Key factors include is there a paid vacation, sick leave or retirement benefits?, is the job a one time thing or an indefinite time frame?

Please note that a written contract between the parties will not override the above!  Here are some things to look at to evaluate whether the worker is an independent contractor or a worker:

They are more likely to be Independent Contractors if:

  • They use their equipment (laptop, phone, tools) to perform the job
  • Work on a temporary basis and are paid “per project”
  • Service other businesses often at the same time
  • Work at their own offsite location
  • Have flexibility to set their own hours and schedule

They are probably workers if:

  • They are paid by the week or the month
  • The obtain training and detailed direction from your business
  • Work full time on a regular basis
  • Perform most of their job tasks on your premises
  • Can be fired at any time
  • They provide services that are an essential part of your day-to-day operations

Remember that these are only basis guidelines – please contact us to review your specific circumstances!

Adopted from The Kiplinger Tax Letter 5/23/14 and efile for 6/19/14

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