IndContractPPT

Independent Contractor vs. Employee:

*Proper Classification and Defensive Measures*

Dan Gibson CPA, EA732- [email protected]

Topics for Today

Summary•The issues

•Types of workers

•Distinguishing between employees and independent contractors

•Performing a self-audit

•Safe harbor relief

•Settlement programs

•Looking forward/Action steps

•Practical Pointers

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The Issues

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Why Classify as IC?

• No employee benefit obligation– Insurance– Matching PR taxes– Pensions

• Allows flexibility in staff size• Easier option for letting go/giving more work• Worker will tend to have greater focus

– Since it is easier to let go.– “On their own”

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Why Should Workers Care?

• No Protections– Minimum wages– OT rule – Health and safety – Family and medical leave

• No Right to join a union• No Unemployment insurance• No Workers compensation(paid by ER)• No Social Security and Medicare (by ER)


Why Does the Government Care?

• Loss in tax collections– In 2006: IRS estimated that $2.72B was

lost in SS, UE and IT.– IRS estimates that they will lose over $7B

over the next 10 years in payroll tax revenue.

• Loss in worker protections…primarily health, disability and unemployment

• ACA Enforcement


Type of Workers

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Making Judgement

• No Bright Line• Federal and State has it different

criteria…Control Test v. ABC Test.– Need to know the criteria being used by

the auditor doing the fieldwork


Employee Definition from IRS

Employee Defined• Every individual who

• performs services • subject to the

– will and – control of an employer (Right v. Actual), – both as to what is to be done and how it's to be

done

• So long as the employer • has the legal right to control both

– the method and – the result of the services.

Business obligated to issue W-29#contractorswebinar

Independent Contractor Defined by IRS

Independent Contractor Defined:• 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.

Business obligated to issue 1099** Under certain conditions


Statutory Employees

• Independent contractor under common law rules treated as an employee for Social Security and Medicare taxes if fall within four categories.– Delivery Drivers (Food, laundry, dry-cleaning, etc.)– Life Insurance Sales Agents (Working for 1 Company)– Home Workers (Pieceworker)– Traveling B2B Salespersons (Mfg Reps)

• Allowed to report work-related expenses on Sch C instead of Sch A.

Business obligated to issue W-2 (check box)


Statutory Nonemployees

• Statutory workers not treated as employee for WH, Social Security and Medicare if fall into one of two categories– Direct Sellers (consumer product to consumer)

• Outside showroom or retail store• i.e. Door to door salesperson, newspaper delivery

– Licensed Real Estate Agents

• They must file a Sch C and Sch SE within their personal tax returns (Form 1040)

Business not obligated to issue W-2


Incorrect Classification - Consequences

• Fed Withholding/ FICA taxes and P&I exposure

• Trust Fund recovery penalty is 100% of the tax

• Risk to Ee benefit plans• Federal wage and hour actions (i.e.

overtime, minimum wage) • State issues: retroactive workers

compensation, disability, vacation, vesting, P&I,etc.


New Era of Increase Enforcement

• Partners in Cooperation– IRS and US DOL.– Fed and State.

• IC misclass is #1 priority for Wage and Hour Division of US DOL.

• IRS Employment Compliance Program has been going on since 2009.

• Hundreds of new trained agents in this area.• Affordable Care Act (ACA)


Distinguishing Between Ee vs. IC

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IRS20 Factors ---- The Broad Category Test

• IRS had developed a list of 20 factors (Rev. Rul. 87-41)

• Three broad categories of examination (since 1990’s)

1. Behavioral control 2. Financial control3. Relationship of the parties

• Totality of the facts and circumstances• No one factor dispositive


IRS 20 FACTOR TEST:INDEPENDENT CONTRACTOR OR EMPLOYEE

REV. RUL. 87-41 LISTS 20 COMMON LAW ATTRIBUTES

1. Instruction LevelWorkers who are required to comply with others’ instructions

about when, where and how they are to work are ordinarily employees.

2. Training Requirements Training workers indicates that employers exercise control over

the means by which results are accomplished.

3. Business Information When the success of continuation of a business depends on the performance certain services, the workers performing those

services are subject to a certain amount of control by the owners of the business.

4. Personal ServicesIf services must be rendered personally (not assignable),

employers control both the means and the results of the work.

5. Assistants Control is exercised if employers hire, supervise, and pay

assistants.

IRS 20 FACTOR TEST:INDEPENDENT CONTRACTOR OR EMPLOYEE (Cont)

6. ContinuityA continuous relationships between workers and employees indicate

that employer-employee relationships exists. However, an independent contractor arrangement could possibly involve an ongoing relationship for multiple, sequential projects.

7. Schedule The establishment of set hours of work by employers indicates control.

8. Full-time positionsIf workers must devote full time to employers’ businesses, employers

have control over workers’ time. Independent contractors are free to work when and for whom they choose.

9. Work on employer’s premisesWork performed on the premises of the employer for whom the services

are performed suggests employer control, and therefore, the worker may be an employee.

10. Order and Sequence of workControl is indicated if workers are not free to choose their own patterns

of work but must perform services in the sequence set by the employers.


11. Reporting RequirementsControl is indicated if workers must submit regular oral or written report to

employers.

12. Payment ArrangementsWhen an individual is paid hourly, weekly, or monthly, this indicates an

employer-employee relationships, provided that this method of payment is not just a convenient way of paying a lump sum agreed on as the cost of a job. Independent contractors are usually paid by the project completion or on straight commission.

13. Accountability and Payment of business and/or traveling expenseEmployers paying workers’ expenses of this nature shows that employer-

employee relationships usually exists. Typically, independent contractors either pay for their own expense and set their fees high enough to account for these costs they expect to incur.

14. Tools and materialsIf employers furnish significant tools, materials, and other equipment

employer-employee relationships usually exists.

15. FacilitiesIndependent contractors typically invest in and maintain their own work

facilities that are not typically maintained by employees. Employees depend on employers for such facilities.


16. Profits or lossesWorkers who can realize profits or losses are independent contractors.

In contrast, Workers who have little chance to receive significant profit or loss through their work are generally employees.

17. Ability and access to work for multiple companiesIf workers perform services for a number of unrelated persons at the

same time, they are usually independent contractors.

18. Availability to work for the publicWorkers are usually independent contractors if they make their services

available to the general public on a regular and consistent basis.

19. Discharge rightsThe unilateral right of employers to discharge workers indicates that the

workers are employees. In contrast, a company’s ability to terminate independent contractor relationships generally depend on contract terms.

20. Termination rightsWorkers are employees if they have the right to end their relationship

and their relationships with their principals at any time without incurring liability. Independent contractors cannot avoid liability except as allowed under their contracts.

IRS Broad Category Test

• Behavioral control– Type of instructions given to the worker: – when, where, and how to do the work; – what tools to use; what workers to hire; – who must perform what work; – where to purchase supplies; – sequence or order of work

• Degree of instruction: more detailed or less detailed• Evaluation systems: measure how the work is

performed or just the end result• Training: provided or required by recipient of services;

subject of training


IRS Broad Category Test(continued)

• Financial controlS Degree of worker investment in business

S Unreimbursed expensesS Opportunity for profit or lossS Services available to othersS Method of billing and payment



• RelationshipS Written contracts

S “Employee” benefitsS Indefinite term/expected duration of

relationshipS Key or integral part of business



• Other factorsS Right to terminate (by worker or business)S Fixed hours of workS Full time requiredS Working for more than one business at a time


US Department of Labor Classification of Employees

• DOL uses an Economic Realities Tests that focuses on the level of worker’s dependence on the service recipient

• Six General Factors1. Are services an integral part of employer’s business

2. Permanency of relationship

3. Worker’s investment in facilities and equipment

4. Control over worker

5. Worker’s opportunity for profit and loss

6. Skill required to perform job and degree of judgement needed for success


States

• Some states use various versions of their own Economic Reality Test.

• Others, including New Jersey, use variations of the ABC test, a more demanding standard.


New Jersey DOL standard The ABC Test

• Many states including NJ use the ABC test, under which, services performed for payment are deemed employment unless ALL of the following are satisfied:A. Worker has been and will be free from control or

direction over performance

B. The work is outside the usual course of business of the entity for which it is performed, or is performed outside all the places of business of that entity

C. Worker is customarily engaged in an independently established trade, profession, or business


The ABC Test

• Relative strength of one part will not mitigate weaknesses in another.

• C Prong is normally the most troubling:– Operate under a trade or corporate name– Have biz cards, stationery, biz phone– Work for other companies, so income is

not derived from just the auditee.• How much effect will not being able to work at

auditee effect the worker?


Performing Self-Audit

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What Triggers an Audit?


Forms Need to Stay Compliant - IRS


• Form W-9, Request for TP Number and Certification

Self Audits

• Independent Contractor vs. EmployeeS Prepare checklist/questionnaire based on IRS and

DOL factorsS Review files on all workers classified as independent

contractors and review contracts, agreements, separate entity documentation, and see if documentation is current

S Review billing and payment records S IC should be formally billing you.


Contract Language

• Center on Independent Business Relationship• No right to control. Work done upon customer

satisfied.• Responsible for own Assistants• Compensation stated as a “fee”• Employment disclaimer from both parties• Address 20 factors/Broad Categories as

deemed appropriate


Practical Considerations

• Ind Contractor– Self directed and

controlled. Deliverable only.

– Multiple customers– Paid by project– No training from

employer– No Ee benefits– Has own tools of

trade//No Support

• Employee– One employer– Provided tools of the

trade/Provided support– Guaranteed pay– Training from employer– Receives benefits– Given direction by

employer on how work is to be performed and controlled.


Safe Harbor ReliefSettlement Programs

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Now What? - Employer Exposure

• Benefit Plans - Kenney, TC Memo 1995-431 – Accrued Benefits Become Taxable

• Employment Taxes (including P & I)– FICA, Withholding (3 most recent years)– 15.3%(FICA), 25%(WH) ~ 40% Tax Rate

• Personal Liability on Trust Fund Amts– EE Portion of FICA, Withholdings.


• First line of Defense• Do now• Little, if any, effect for state purposes• Part of the Revenue Act of 1978 – Not in Code• Made permanent by Congress in 1982• Effect

– Allows potential misclassification

• Must demonstrate following:– Reporting consistency– Substantive Consistency– Reasonable basis

Section 530 Safe Harbor - Intro


Section 530 Requirements

• All Required Docs filed – 1096/1099s (Reporting)– Requirement for filing 1099s for Businesses

• All unincorporated service providers…$600 or +• New question on business returns [Required?/Filing?]

• Each group of workers treated consistently (Substantive) – i.e. -

• Salespeople• Delivery personnel

• “Reasonable” basis must be established – See Next Slide


Section 530 – “Reasonable Basis”

• Revenue Rulings – Supporting Your Facts• Court Cases – Supporting Your Facts• Prior Audit…. No assessment on worker classification • Industry Practice (at least 25% following)• Any other “reasonable basis”

– Written advice from• Qualified attorney• Qualified accountant


Using Section 530 - Continued

• Audit Strategy– Use as many categories of workers as practical

• Can help isolate damages

– Statute of Limitations• File Payroll Returns (940s, 941s) timely

– Even if no employees

– Be Prepared to Address at the Start


Section 3509 Relief

• Eases tax treatment on misclassification– Otherwise, paying full EE & ER WH and FICA (40%) * 3Yrs

• Misclass made w/reasonable basis attempt.– WH: 1.5% of wages– FICA: 20% * 7.65% * EE FICA Wages

• Misclass made w/o reasonable basis attempt.– WH: 3.0% of wages– FICA: 40% * 7.65% * EE FICA Wages

• Keep in mind…you’ll still owe 100% ER FICA portion• Most have filed 1099!• Must agree to report as W-2 going forward.


Classification Settlement Program (CSP)

• Available for businesses under exam.• Gov’t attempt to expedite the issue• Requirements

– Filed 1099s in the past.– Made a good faith effort to maintain consistent

treatment amongst worker groups– Can make a reasonable basis argument– ER must agree to proper prospective classifications


CSP - Assessment

• If reporting requirement met, but consistency of worker groups or reasonable basis not met:– Full employment tax assessment for year of examination,

rather than for 3 years.

• If reporting met, worker classification consistency met and reasonable basis attempt is made:– Assessment of 25% of tax, using Section 3509

computations, for the year under exam


Voluntary Classification of Settlement Program (VCSP)

• Started in 2011• Allows taxpayers, not under audit, to reclass ICs to EEs.• Requirements

– Not being audited by IRS, DOL or other state agency

– Consistent reporting of worker group

– Forms 1099 filed

• In exchange– ER pays 10% of the employment tax obligation under 3509

– No interest or penalties

– No employment audit of re-classed workers in PYs

– However, extends statute for first 3 years after reclassification• Making it a 6 year statute for each of the 3 years following.


Tax Exposure and Tax Relief Example

Facts: Business has 60 misclassified ICs earning $50K eachS Total Payout……60 * 50K = $3,000,000 Total Payouts to ICs

•Full Rate: $3,000,000 * 40% = $1,250,000•Section 3509 relief

– $3M *(7.65%ER+1.53%EE+1.5%WH) = $320,400*3 years ($1M)

•CSP– 100%....Similar to Section 3509, but for 1 year only ($320,400)

– 25%...... $320,400 * 25% = $80K

•VCSP– $320,400 * 10% = $32K

•Section 530– $0


Relief for NJ DOL

• A Shoulder• A Tissue• Seriously,

– Report as an employee for NJ for unemployment and disability purposes.

– If not, set aside $5,000 “at-risk” independent contractor for assessment if subject to a DOL audit.


Looking Ahead Forward

• Healthcare Legislation– Small Biz Credit– Large Biz Penalty

• New 1099 Reporting Requirements for Entity Returns• 2010 IRS National Research Project• Sharing of Information between agencies: IRS – Fed

DOL, IRS/Fed DOL - States


Action Steps for Employers

• IC Agreements – Address Behavioral Controls, Financial Controls, Relationship

• IC proposals should specify projects, not commitments to work a certain amount of hours or days. If applicable, discuss deliverables.

• Other helpful factors– IC should show evidence of working for multiple biz– Show that TP uses multiple ICs – IC had their own biz cards, phone listing, license,

biz location, tools, etc.– IC is incorporated

• Issue 1099s#contractorswebinar 48

Practical Pointers

If you are going to be aggressive, make sure you:1.Plan ahead – Make sure your line up your ducts as best as possible.2.Continually audit – If relationship evolves into an employee relationship, make the change and contemporarily document why the change was made.3.Draft sound contractor agreements

– If possible, add indemnification provision to cover any local, state and federal taxes.


Practical Pointers (Cont)

If you are going to be aggressive, make sure you:4.Obtain W-9s5.Issue 10996.Get copy of licenses7.Get proof of liability insurance/workers’ comp if they have employees.8.Should be listed as a AP vendor9.Payment should be by invoice only


IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.

EisnerAmper LLP is an independent member firm of PKF International Limited

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