Worker classification and the evolving service delivery model.

• Author: Mort, Kathy

Determining whether a worker is properly classified for tax purposes as an independent contractor or an employee is complex. The fact-intensive nature of this inquiry is complicated because the criteria and methodologies used by the IRS to assess a relationship between the service provider and the service recipient often differ from those used by other federal or state government agencies, including the U.S. Department of Labor (DOL) and the National Labor Relations Board (NLRB).

For federal employment tax purposes, this issue generally relates directly to a business's liability for payroll taxes: federal income tax withholding; Social Security and Medicare (together, Federal Insurance Contributions Act (FICA)); and Federal Unemployment Tax Act taxes. However, worker classification has a broader, significant impact. It affects a worker's entitlement to pension, health, and welfare benefits; the applicability of minimum wage and overtime provisions; and a worker's ability to claim unemployment, workers' compensation, and disability coverage.

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Further, since enactment of the Patient Protection and Affordable Care Act (PPACA), P.L. 111-148, there have been concerns over the impact that worker misclassification may have on an employer's potential liability under Sec. 4980H. That section generally provides that applicable large employers, i.e., those with at least 50 full-time employees, are subject to an excise tax if at least one full-time employee is certified as having enrolled in a qualified health plan for which a premium tax credit or cost-sharing reduction is allowed or paid (i.e., via a health care insurance exchange). As a result, employers that already face substantial exposure for employment tax liabilities also may be subject to significant excise tax assessments under PPACA for misclassification.

Common Law Standard

Congress adopted the common law standard in defining "employee" for FICA purposes in 1948 (Sec. 3121(d) (2)), rejecting an economic-reality test (see S. Rep't No. 1255, 80th Cong., 2d Sess. 3-4 (1948)). Under common law, the treatment of a worker as an independent contractor or as an employee originates from the legal definitions developed in the law of agency--whether one party, the principal, is legally responsible for the acts or omissions of another party, the agent. Following the common law standard, the employment tax regulations provide that an employer-employee relationship exists when the...