IRS Provides Additional Written Guidance to Assist With Employee vs. Independent Contractor Determination

by Steven Sodini 7. June 2012 10:03

In October, 2011, the IRS published late Summertime Tax Tip 2010-20, in April, 2012, the IRS issued IRS Publication 1779, and in May, 2012, the IRS published an additional article called “independent contractor or employee?”, all of which attempt to provide some additional written guidance and resources to the longstanding employee vs. independent contractor debate, in an effort to assist both individuals and business owners.  Generally, businesses must withhold income and FICA taxes, and pay unemployment taxes for employees, but are not required to do so for independent contractors, so it is very important for both the business and individual to accurately make this determination in advance of the employment.

IRS Publication 1779 outlines three primary characteristics that the IRS will use to determine the relationship between businesses and workers:

The first factor, “behavioral Control” looks at facts that show whether or not a business has a right to direct or control how a worker does the work through instructions, training, or some other similar manner.  Instructions can include how, when, or where to do the work, what tools to use, what assistants to hire, and where to purchase supplies and services.

The second factor “financial control” examines facts that show whether or not a business has a right to direct or control the financial and business aspects of the work.  An individual may be classified as an independent contractor if they have significant financial investment in their work, if they have a high percentage of unreimbursed business expenses, or if they can realize a profit (or incur a loss).

The final factor “relationship of the parties” analyzes facts that illustrate how both the business and the worker perceive their relationship.  Some examples of this factor include whether or not an individual receives employee benefits and whether or not there is a written contract that demonstrates the intent of the parties.

Summertime Tax Tip 2010-20 notes that if a business has the right to control or direct not only what is to be done, but how the work is to be done, then the workers are most likely employees, but if the business cannot control how it is to be done, then the workers are most likely independent contractors.  In addition, the tax tip notes that employers that misclassify workers as independent contractors can end up with substantial tax bills and penalties.  Finally, it is noted that both employers and workers can petition the IRS directly to make a determination, by filing form SS-8.

Since this issue is ultimately decided by a facts and circumstances test, it is certainly welcome news that the IRS has issued additional written guidance to aid taxpayers in the determination.  However, it remains to be seen how this guidance will be received by the courts when similar issues are litigated in the future.

Please note that additional information and links to the forms and publications referenced in this discussion can be accessed at the following sections of the IRS website: http://www.irs.gov/newsroom/article/0,,id=173423,00.html and http://www.irs.gov/businesses/small/article/0,,id=99921,00.html

 

 

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