Employment status can be a tricky situation to discern. Employers who are found to have improperly classified a worker might have to pay hefty fines and back taxes to relevant government agencies. Therefore, it is imperative that the status of workers be determined properly. Compensation paid to workers classified as employees are subject to withholding of federal income tax, FICA (Federal Insurance Contributions Act) and Medicare taxes. The employer will have state unemployment tax obligations on these wages as well. Fringe benefits and retirement plan coverage, if offered by the employer, must also be available to employees. A business would not have these responsibilities for independent contractors. The independent contractor receives a Form 1099-MISC for payments received and pays self-employment tax.
Three hypothetical employment scenarios:
Joe enlists the services of Frank to help in the incorporation of his company. Joe pays Frank for his services. Is there an employer-employee relationship between the corporation and Frank? Is the compensation paid to Frank subject to tax withholding?
Dough Corporation manufactures bakery products. Route distributors (drivers) are used to deliver the baked goods. The route distributors set their own hours and determine where the product is sold. Is there an employer-employee relationship between Dough Corporation and the route distributors? Is the compensation paid to the drivers subject to tax withholding?
Lisa, an industrial hygienist, entered a one-year contract with the U. S. State Department as a specialist to perform authoritative work. She worked under minimal State Department control and did not receive any employee benefits. Is there an employer-employee relationship between the U.S. State Department and Lisa?
Workers are either independent contractors or employees by law. Under common-law rules, anyone who performs services for you is your employee if you have the right to control what will be done and how it will be done (common-law employees). The Internal Revenue Service and the courts use the common-law rules to determine whether an individual is an employee or an independent contractor depending on the facts in each situation using the "11 main tests." The more control the facts show, the more likely the worker is classified as an employee.
The 11 main tests are organized into three main groups: behavioral control, financial control and the type of relationship of the parties. All the tests boil down to whether the employer exercises direction and control over the performance of the services of the worker.
Facts to be considered under the behavioral control group:
1. Instructions that the business gives to the worker.
2. Training that the business gives to the worker.
Facts to be considered under the financial control group:
3. The extent to which the worker has unreimbursed business expenses.
4. The extent of the worker's investment other than his or her time.
5. The extent to which the worker makes his or her services available to the relevant market.
6. How the business pays the worker.
7. The extent to which the worker can realize a profit or loss.
Facts to be considered under the type of relationship group:
8. Written contracts describing the relationship the parties intended to create.
9. Whether or not the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay.
10. The permanency of the relationship.
11. The extent to which services performed by the worker are a key aspect of the regular business of the company. The company would have the right to control or direct the work if the company can present the end product from the worker's services as its own.
Nevada Unemployment Compensation Law uses what is commonly referred to as the "ABC" test to define "independent contractor." The "ABC" test is unique to the Unemployment Compensation Program. Payment for personal services is deemed subject to unemployment taxes unless all three of the following conditions are met:
A. The person is free from control or direction in the performance of the work.
B. The work is done outside the usual course of the company's business or is done off the premises of the business.
C. The worker is customarily engaged in an independent trade, occupation, profession or business.
Common-law employees are subject to withholding of federal income tax, FICA and Medicare taxes. An individual is an "employee" for tax withholding purposes if there's a legal employer and employee relationship at the time of the services rendered.
Workers may be classified as employees, independent contractors or statutory employees. Although workers may be independent contractors under the common law rules, there are circumstances whereby they are treated as employees by statute for FICA and Medicare tax purposes. Statutory employees are not subject to income tax withholding. Certain drivers, life insurance salespeople, home workers and other sales people are statutory employees if they meet all of the following:
1. They are not corporate officers who are treated as employees.
2. They are not common-law employees.
3. The contract of service states or implies that worker perform substantially all of the services himself.
4. The worker does not have a substantial investment in equipment and property used for doing the work, other than transportation equipment.
5. The services are performed on a continuing basis for the same payer.
In the first example, Frank received payment for services performed before the actual incorporation of Joe's company. The employer-employee relationship cannot exist between an individual and a non-existent entity. Therefore, Frank's compensation is not subject to tax withholding.
The facts in the Dough Corporation and the route distributors (drivers) example would indicate that there is no employer-employee relationship. The route distributors fit within the definition of statutory employees provided by the regulations. The compensation paid to the route distributors are subject only to FICA taxes.
Lisa was contracted for her special skills to solve a problem. Her contract was for a specific time frame and she worked independently. The facts would indicate Lisa was an independent contractor and her compensation would not be subject to tax withholding.
Kam L. Chan is the director of tax administration for Barnard, Vogler & Co. in Reno.
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