- DETERMINING HIRING STATUS
- LEASED EMPLOYEES
- BENEFITS ELIGIBILITY AT-A-GLANCE
- FORMS AND CHECKLISTS
- Who is eligible for benefits?
- Who is an employee?
- Are there penalties for improper classification?
- What determines the employer-employee relationship?
- Are the special rules for professionals?
- How can an employer protect employment status?
- How are leased employees treated?
The first step in determining whether an employee is entitled to company benefits is to resolve the hiring status of a new recruit. In other words, is the worker actually a company employee or merely an independent contractor. This distinction is important because employees will be entitled to participate in the company’s benefits programs, while independent contractors would not be.
From the employer’s side, in addition to benefits, the employer must generally withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.
Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be –
An employee (common-law employee)
Determining whether the new recruit is an employee or an independent contractor is crucial. The Internal Revenue Service (IRS), as well as other government agencies do not take this matter lightly, as there are many tax consequences and other legal ramifications associated with this determination.
Whatever the arrangement, the understanding should be confirmed with proper documentation. Failure to include such documentation in the files can leave a business vulnerable to challenge in the future. Such challenges are being led by the federal, state and local governments as they tap avenues for additional revenues through payroll tax deficiencies and penalties for failure to abide with employment rules.
Normally, a business is inclined to hire an independent contractor in cases when it wants to avoid the responsibilities and burdens of an employment relationship. These include payroll tax expenses, wage withholding requirements and costs associated with eligibility for other benefits packages. Such costs include pension plans, health insurance and other fringe benefits such as workers’ compensation and state requirements related to employment taxes and rules in the workplace.
From the new hire’s perspective, an independent contractor enjoys freedom from “control” and the opportunity to take advantage of the ability to deduct business-related expenses directly on their personal tax return.
Given that the law does not provide a specific definition of “who is an employee,” a worker is deemed to be an “employee” based on the common law rules, statutory definitions or specific tests, that have developed as a result of historical case law.
An “employer-employee” relationship exits when an employer has the right to:
- Control and direct what work is to be done;
- Control and direct how the work is to be done and provide the details and means to fulfill the tasks and responsibilities; and
- Control and direct when the work is to be done.
However, certain workers can be held to be employees regardless of the common law tests described below. Certain workers enjoy relief from “employee” status if they are deemed to be “statutory independent contractors.” Moreover, relief from employment taxes is possible if a worker is not treated as an employee for a period of time and a reasonable basis exists not to do so.
The IRS has established a 20-factor control test to determine whether a worker is an employee or independent contractor under the common law definition. The list is merely a guideline and is not all-inclusive. If these factors are present, the IRS will presume the worker to be an employee of the employer.
To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. All evidence of control and independence must be considered. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
The business cost of hiring employees generally exceeds the cost of using independent contractors. But, this statement must be prefaced by the assumption that based on the facts and circumstances, the taxing authorities cannot assert that an “employee” status exists. Should a taxing authority successfully argue that “employee” status exists, the penalties can be extensive.
Penalties can be assessed for the improper classification of an independent contractor. The nature and amount of the penalties depends upon the intent of the employer.
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.
Leasing employees is becoming increasingly popular, as employers are struggling to keep benefits and payroll costs down. This option, however, must be given careful consideration in light of the restrictions imposed in the tax laws to curb abuse of this alternative.
- Determining whether a new worker is an employee or an independent contractor is crucial.
- Whatever the arrangement, the understanding should be confirmed with proper documentation.
- The business cost of hiring employees generally exceeds the cost of using independent contractors.
- Penalties can be assessed for the improper classification of an independent contractor.
- The IRS has established a 20-factor control test to determine whether a worker is an employee or independent contractor.
- The law allows a measure of relief, in that it permits an employer to treat certain common law employees as independent contractors.
- A business can protect the understanding that an individual is an independent contractor by having the individual sign an “independent contractor agreement.”
- Leasing employees is becoming increasingly popular, as employers are struggling to keep benefits and payroll costs down.
- Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF)
- Forms and associated taxes for independent contractors
- Forms and associated taxes for employees