Balancing Act

So it seems that the IRS will be taking a closer look at how small and medium-sized businesses classify their payments for hired help. Depending on the situation that exists between your business and the person you have working for you, you may be forced to rethink your working relationship.

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According to IRS Publication 15-A there are four ways one can be classified:

An independent contractor,

A common-law employee,

A statutory employee, or

A statutory non-employee.

In simple terms an independent contractor would be someone who offers their services to the public and is not an employee. To determine if you have a relationship with an independent contractor the IRS looks at who controls the way the work is completed. In essence, if the hiring business controls the method or the means that a job is done then that relationship will more than likely be considered to be an employee/employer relationship. If this is the case for your outside help, then prepare to take a W-4 and calculate withholding. Your responsibilities just became more complex.

As mentioned above, if the business controls what will be done and when it will be done then you are an employer of a Common-Law employee. Essentially the IRS does not care what you call the relationship. You are an employer subject to all of the fun and responsibilities that go with it.

The next category is the Statutory Employee. I suggest you take a look at the publication for specifics but this covers some delivery drivers, insurance agents, homeworkers that work on supplied materials and return the completed materials to you or someone you specify, and lastly, traveling sales people. For workers in this category the business must withhold Social Security and Medicare contributions.

The last category is the Statutory Non-employee. This group of people are direct sellers whose pay is directly related to what they sell and not on time. This is also true if the individual is working under a contract that states that they are not treated as an employee for federal tax purposes.

Essentially the IRS looks at this relationship using three categories:

Behavior Control

Financial Control

Type of Relationship

For the behavior control test, The IRS looks at the type and degree of instruction given to the worker.
Some the behavior controls the IRS looks at are the following:

When and where to do the work.

What tools or equipment to use.

What workers to hire or to assist with the work.

Where to purchase supplies and services.

What work must be performed by a specified individual.

What order or sequence to follow.

To establish that a worker is in fact an independent contractor, the IRS will look at the financial control an independent worker has.

Unreimbursed Business Expenses:
In general, independent contractors are more likely to have unreimbursed expenses than employees.

Worker’s investment:
Typically an independent contractor will have a significant investment in equipment or facilities used to perform services for someone else.

Are services offered to the relevant market:
An independent contractor is generally free to seek out other business opportunities.

Compensation of the worker:
Employees are usually guaranteed a regular wage amount. Independent contractors are paid by a flat fee for the job or on a commission basis. However, it is common in some professions, such as law, to pay independent contractors hourly.

Workers’ ability to control their profit or loss:
Typically independent contractors can make a profit or loss. This is usually evidenced by the worker maintaining a set of books for their business.

The third area that the IRS looks at to determine the working relationship is the relationship.

Evidence of the working relationship includes:

Written contracts describing the relationship between the business and the worker.

Whether the business provides the worker benefits that are typical of an employee relationship, such as insurance, vacation pay, etc.

Is the relationship focused on a period of time or project? Relationships that are established for an indefinite amount of time are more likely to be considered to be an employer/employee relationship.

Is the worker participating in the key parts of the business? If the worker is involved in the business’es main function then the IRS presumes that that the business will be more likely to exercise control of the work performed.

What is clear is that the employee/contractor relationship is not clear at all. However, the IRS will be taking a much closer look at these complex relationships as they suspect that many employees are being misclassified as independent contractors.

If you are a business owner we suggest that you contact your tax preparer to determine if your workers are properly classified.

If you are working as an independent contractor we suggest that you maintain proper records for your business activity.

In any case we are happy to help so please feel free to give us a call at (203) 404-3974 should you wish to discuss your particular situation.