Worker classification and taxes, part 2: What is the legal test?

In the first part of this post, we began discussing the issue of worker classification for purposes of paying (or avoiding) payroll taxes.

The issue of worker vs. contractor has been around for years, but is as timely as ever. As we noted, this is because revenue agencies have been stepping up their scrutiny of employer classification decisions by doing an increasing number of audits.

In this part of the post, look more closely at the legal test for distinguishing independent contractors from employees with regard to payroll taxes.

The term “payroll taxes” is often used interchangeably with “employment taxes.” In practice, there are actually several different taxes involved. For starters, Social Security and Medicare taxes are imposed under the Federal Insurance Contributions Act (FICA).

When you pay wages to an employee, there is also unemployment tax to be paid. And there are also obligations on employers to withhold income taxes for employees.

With independent contractors, employers don’t have these tax payment and withholding obligations. But just how is it that you distinguish an employee from a contractor or consultant who is considered self–employed?

The traditional legal test for distinguishing an employee from a contractor has centered on the degree of control and level of independence that the worker has in going about the work.

The IRS views the degree of control and independence based on three main categories. The first is behavioral, looking at whether the employer controls or has the right to control the work. But there are also factors to be considered involving financial considerations and the type of relationship.

Financial considerations include things like how payment is made and how expenses are treatment (reimbursed or not). The factor concerning type of relationship looks at such elements as the existence and terms of a written contract, the duration of employment and eligibility for benefits.

Even with all of this analysis, however, it can be difficult for both employers and workers to be certain about what a given worker’s status is. When that is the case, one option is to complete and submit Form SS-8, asking for a determination of this status by the IRS.