October 2018 JD Supra
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What is your Work Status? Employee or Independent Contractor? was published by JD Supra on 10/25/18.

Worker classification or work status has an effect on how a Taxpayer will pay federal income taxes, social security and Medicare taxes, and how a Taxpayer files a tax return. Classification can affect a Taxpayer’s eligibility for Social Security and Medicare benefits, employer provided benefits and the Taxpayer’s tax responsibilities.  

The distinction between employee and independent contractor is an important one under US tax law. Common law rules are usually applied and the relationship between the “worker” and the “business” has to be evaluated.  In the evaluation of the relationship between the “worker’ and the “business”, “the degree of control and independence” in the relationship is determining. As evidence of the “degree of control and independence”, the following are examined:

  • Behavioral Control:  Does the business have a right to direct and control the work accomplished and how the work is done by the worker (whether is done via a type of instruction, degree of instruction, evaluation systems or training)? If the worker receives extensive instructions on “how” work is to be done and when/ where to do the work, then the worker can be viewed as an employee.  Other instructions such as what tools or equipment to use, hiring assistants to help with the work and direction as to where to purchase supplies and services are also indicators that the worker is an employee.

If the worker receives a lesser amount of instructions regarding what should be done, but not how it should be done, the worker could be viewed as an independent contractor (instructions about time and place may be less important than directions on how the work is performed).  Training about required processes and methods provided by the business may suggest that the worker is an employee as these types of instructions indicate that the business wants things done in a certain way.

  • Financial Control:  Does the business have a right to direct or control the business part of the work performed by the worker?   If the worker has significant investment in the work performed, the worker may qualify as an independent contractor. There is no precise dollar amount test to determine if the worker has a substance investment.  Nonetheless, a significant investment by the worker is not necessary to be an independent contractor. If the worker is NOT reimbursed for some or all business expenses incurred, the worker might be viewed as an independent contractor.  If the worker is given the opportunity to realize a profit or takes a loss in the business, then the worker is viewed as an independent contractor.
  • Relationship of the Parties:  What type of relationship does the worker and the business have?  Are there written contracts describing the relationship? Does the business provide the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay? Is the work done by the worker a key aspect of the regular business of the company?

If You Are an Employee

Your employer must withhold income tax and the worker’s portion of social security and Medicare taxes as well as pay worker’s social security, Medicare, and unemployment tax on wages and distribute Form W-2.  

If you are an Independent Contractor

A business may be required to issue you a Form 1099-MISC (Miscellaneous Income) to report what you have been paid during a year.  In turn, an independent contractor is responsible for paying its own income tax and self-employment tax (Self-Employment Contributions Act – SECA).  A business does not withhold taxes from an independent contractor’s pay. Independent Contractors need to make estimated tax payments during the year to cover their tax liabilities.

Does it make a difference for the business if you are and employee or an independent contractor?

Businesses tend to prefer workers as independent contractors rather than employees.  It is estimated that classifying workers as independent contractors can save a business 20 to 30 percent.  A recent ruling by the California Supreme Court (https://scocal.stanford.edu/opinion/dynamex-operations-west-inc-v-superior-court-34584) noted that:  

“if a worker should properly be classified as an employee, the hiring business bears the responsibility of paying federal Social Security and payroll taxes, unemployment insurance taxes and state employment taxes, providing worker’s compensation insurance, and, complying with numerous state and federal statutes and regulations complying with numerous state and federal statutes and regulations governing the wages, hours, and working conditions of employees. The worker then obtains the protection of the applicable labor laws and regulations. On the other hand, if a worker should properly be classified as an independent contractor, the business does not bear any of those costs or responsibilities, the worker obtains none of the numerous labor law benefits, and the public may be required under applicable laws to assume additional financial burdens with respect to such workers and their families”.

The ruling also states that:  “misclassification of workers as independent contractors rather than employees is a very serious problem, depriving federal and state governments of billions of dollars in tax revenue and millions of workers of the labor law protections to which they are entitled”.

Don’t be a victim of your own making

If you are a participant in the “sharing economy” or “gig economy”, or if you are an independent contractor, consult your tax specialist. The sharing economy is a fast developing area of the economy and there are tax implications for the businesses that provide the services and the individuals who perform the services.