Employee or Independent Contractor

Date01 March 2016
Published date01 March 2016
© 2016 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22150
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.
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
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

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