IRS Focus: Worker Classification

Worker classification – categorizing a worker as either an employee or independent contractor – varies from organization to organization and can be confusing. The IRS has begun to focus on classification of workers by an organization, conducting employment tax audits and compiling data about employers’ compliance with IRS rules involving employee versus independent contractor reporting.

While guidelines are available from the IRS to assist in making these, the following should provide some helpful information.

Employee vs. Independent Contractor

A worker is considered an employee if you (as the employer) have the right to control what will be done and how it will be done. 

If you have the right to control or direct only the result of the work and the worker determines the means and methods of accomplishing the desired result, then that worker is more likely classified as an independent contractor (IC). 

Classification Criteria

Regardless of the label assigned to a worker, several facts which fall under behavioral control, financial control and relationship, are critical in determining the proper classification of individuals. They are:

Behavioral control:

• Employees are provided with extensive instructions (how to do work, what tools/equipment to use, who to work with).
• Employees are also trained and evaluated on procedures and methods for completing work.

Financial control:

• Employees use the resources of the organization and many times do not make a personal financial investment.
• Employees are typically reimbursed by the organization for expenses incurred in performing their work.
• Employees do not directly realize a profit or loss from the results of the work.
• Employees are normally paid based on the time worked (hourly, weekly, annually) versus being paid by job or project.
• Employees regularly work for one organization; whereas an independent contractor’s income may come from several different sources.

Relationship:

• Employees may receive benefits from the organization, including insurance, retirement and sick days.
• Employment agreements or contracts may show evidence of the relationship between the parties and help in the decision of how to classify a worker, even if the individual has been misclassified.
• Employer-employee relationships are often expected to last indefinitely.
• An employee’s activities are often related to a key activity of the business.  This relationship also allows the organization to direct the employee’s activities.

Officers of an organization are considered employees by the Internal Revenue Code, regardless of the facts outlined above.

Payroll Taxes and Reporting

The organization is responsible for remitting payroll taxes for all employees (Social Security, Medicare, and unemployment taxes).  At the end of the year, each employee should be issued a W-2. 

No payroll tax withholding is required for ICs.  An IC’s earnings are reported on Form 1099.

Assistance Is Available

If, after examination of all facts in your case, you are still unsure of the correct classification of a worker, the organization can file Form SS-8 to request IRS assistance in determining the correct classification of a worker.

If you classify an employee as an IC and cannot support the classification with relevant facts, the IRS may assess the full amount of employment taxes and related interest and penalties for the worker in question on the organization.

The IRS is focusing on worker classification and the proper remittance of employment taxes by all employers, including nonprofit organizations.  This is an area that should be carefully examined to ensure that your organization is in compliance with reporting requirements.

If you feel you have exposure due to misclassifications, there are relief provisions available. Smith and Howard’s professionals are available to answer questions about worker classification or relief available for misclassifications.  Please call Marvin Willis at 404-874-6244.