Employee or Independent Contractor

• Date: 01 March 2016
• DOI: http://doi.org/10.1002/jcaf.22150
• Published date: 01 March 2016

101

© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22150

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IRS

Employee or Independent Contractor

Shirley Dennis-Escoffier

Businesses need to be aware

of the complex compliance

issues relating to the proper

classification of employees

versus independent contractors

because the determination has

significant tax implications for

both workers and employers.

It affects the determination

of whether the employer is

required to pay Social Secu-

rity taxes, Medicare taxes,

and unemployment taxes and

withhold income taxes, as

well as whether the employer

is required to provide health

insurance. While misclassifi-

cation has been a long-term

concern of the Internal Rev-

enue Service (IRS), the problem

is now more important due

to the Affordable Care Act’s

requirement to provide health

insurance for employees. The

IRS is well aware that busi-

nesses now have even more

incentive to classify workers as

independent contractors and

has embarked on an enforce-

ment project targeting the

misclassification of employees

as independent contractors.

ADVANTAGES OF

INDEPENDENT CONTRACTORS

By using independent con-

tractors instead of employees,

businesses can reduce costs

and paperwork from payroll

taxes, income tax withhold-

ing, unemployment insurance,

workers’ compensation, and

employee fringe benefits. While

these savings have existed for

some time, more businesses are

now looking at independent

contractors as a way to avoid

the requirement under the

Affordable Care Act (ACA) to

provide minimum health insur-

ance to their employees or face

a significant penalty. When

businesses treat their workers

as independent contractors,

the responsibility for paying

the employer’s share of payroll

taxes, as well as any benefits,

is shifted from the employer

to the independent contractor.

Due to these differences, it is

clearly less expensive to hire an

independent contractor than an

employee.

WHO IS AN EMPLOYEE?

An individual is an

employee for federal employ-

ment tax purposes if the

individual is considered an

employee under the common-

law test applicable in determin-

ing the employer–employee

relationship. Although the

Internal Revenue Code (IRC)

does not define the common-

law test, several provisions in

the IRC and related regulations

make reference to it. Forexam-

ple, IRC Section 3121(d)(2)

provides that a worker shall

be classified as an employee

for Social Security and other

employment tax purposes if

the worker is a common-law

employee. Regulation Section

31.3121(d)−1(c)(2) states that

an employer–employee rela-

tionship generally exists when

the business has the right to

control and direct the work

of the worker, not only as to

the result to be accomplished

by the work, but also as to the

details and means by which

that result is accomplished.

Theregulation further states

that the mere right to direct or

control the work of the service

provider is what is important

and not whether the right is

actually exercised.

Regulation Section

31.3401(c)−1(b), which defines

who is an employee for federal

income tax withholding, states

that the right to discharge is

an important factor indicat-

ing that the person possess-

ing that right is an employer.

Otherfactors characteristic of

an employer include furnishing

tools and furnishing a place