Should My Workers be Employees or Independent Contractors?

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Treating a worker as an employee typically costs the employer more than treating the worker as an independent contractor.  If a worker is properly characterized as an employee, the employer will be required to pay the employer-portion of the social security and medicare taxes, withhold the employee-portion of social security and medicare taxes, pay unemployment tax, pay workers compensation premiums, pay the employer-portion of any pension or profit-sharing plan contributions, health plan contributions and other employee fringe benefit programs, provide vacation, sick days and maternity leave for the worker, and otherwise permit the worker to participate in all employer-sponsored employee benefit and welfare programs.

On the other hand, if the worker is properly characterized as an independent contractor, the employer is not required to provide any of the above benefits, or pay or withhold any of the above taxes.  The employer is simply required to provide the worker with whatever payments are specified in the independent contractor agreement, and the worker is responsible for paying the appropriate income tax, self-employment tax, workers compensation and other taxes related to such payments.

The IRS looks closely at how employers characterize their workers.  The IRS has a 20 factor test it applies to evaluate whether a particular worker, or group of workers, should be treated as an employee or independent contractor.  Although the IRS test includes 20 factors, theses 20 factors can be summarized into 2 main points of inquiry.  These points of inquiry are: (1) does the employer have the right to control the details of how the worker does his or her job or only evaluate the final product or performance; and (2) does the worker have a real risk of loss.  If the employer has the right to tell the worker how to do his or her job, when to do it, where to do it, when and where not to do it, the worker looks more like an employee.   On the other hand, if the employee is free to do the job when he or she wants to, using whatever procedures or methods he or she wants to, wherever he or she wants to do the job, using assistants or sub-contractors, and the employer controls only the evaluation of the final product or job performance, then the worker is more like an independent contractor.

If the worker is reimbursed for expenses, paid a salary or an hourly wage and is provided a car or tools necessary to do the job, the worker has little risk of loss on the job and looks more like an employee.  To the contrary, if the worker is not reimbursed for expenses, is paid a specified sum for the job and is required to provide his or her own shop or office, transportation and tools, the worker looks more like an independent contractor who runs his or her own business.

Proper classification of workers is important.  If one or more of the workers treated as an independent contractor fails to properly pay income and self-employment tax, and the IRS determines (in its opinion) the worker should have been treated as an employee, the IRS will go after the employer to collect unpaid employee income tax withholding, and both employer and employee social security and medicare taxes.  If this happens, there are some defenses.  The first line of defense is that the IRS is wrong and the worker is properly treated as an independent contractor.  If this does not work, there is a second line of defense based on Section 530.  Section 530 is a piece of legislation that permits the employer to continue treating misclassified workers as independent contractors if certain conditions are met.  More about section 530 in the next Blog posting.   Please call or email if you have any questions about proper classification of your workers.   Jsenney@pselaw.com or 937-223-1130.

AND ONE MORE THING.  Under a Notice issued by the IRS in 2010, if the estate of a deceased spouse fails to use all of his or her federal estate tax exemption, the surviving spouse may inherit the unused portion.  But to obtain this benefit, the estate of the deceased spouse is required to file an estate tax return, even if no return would otherwise be required.  Earlier this year, the IRS announced an automatic extension of time for smaller estates to make an election to transfer the unused estate tax exemption to the surviving spouse.  This automatic extension applies to estates of married individuals with assets of $5,000,000 or less, but only if the deceased spouse died in the first 6 months of 2011, and the executor requests the extension no later than 15 months after the date of death.  Call or email if you have any questions about taking advantage of this extension.