The IRS in looking at the status of a worker for a corporation looks at the employer's "right to control" that individual. If the employer has the right to control the manner in which the worker performs the services, then the worker is an employee. If not, then the worker is an independent contractor.
The IRS when investigating an employer will look at three different categories: behavioral control, financial control, and the relationship between the parties. Behavioral control is then broken into two subparts, that of whether the employer provides instructions on how to do the work or the how and when of the work, and then also provides training on how to do the work. Financial control is analyzed through whether the worker has had significant investment in the business, has unreimbursed expenses from the business, provides his or her service to others in the marketplace, the method of payment to the worker, and the opportunity for profit or loss. Relationship of the parties is determined by examining the intent of the parties at the formation of the relationship, employee benefits, the ability to be discharged or terminate the relationship and the normal regular business activity. The IRS also has 20 factors which go into determining the above. The factors that often lead workers to be classified as employees are if they:
- Must comply with employer's instructions about the work.
- Receive training from or at the direction of the employer.
- Provide services that are integrated into the business
- Provide services that must be rendered personally.
- Hire, supervise, and pay assistance for the employer.
- Have a continuing working relationship with the employer.
- Must follow set hours of work.
- Work full time for an employer.
- Do their work on the employer's premises.
- Must do their work in a sequence set by the employer.
- Must submit regular reports to the employer.
- Receive payments of regular amounts at set intervals.
- Receive payments for business and/or traveling expenses.
- Rely on the employer to furnish tools and materials.
- Lack a major investment of facilities to perform the service.
- Cannot make a profit or suffer a loss from their services.
- Work for one employer at a time.
- Do not offer their services to the general public.
- Can be fired by the employer.
- May quit work at any time without incurring liability.
These factors, though extensive, are not considered dispositive by the courts. The courts often follow a much shorter list. For instance, one court considered eight factors, (degree of control over the details of the work, the worker's investment in facilities, the worker's opportunity for profit or loss, the permanence of the relationship, the principal's right to discharge the worker, whether the work is an integral part of the principal's business, the relationship that the parties intended, and whether fringe benefits are provided) rather than use the IRS's extensive list.
The employee/independent contractor status is important as it determines who is to withhold taxes and what taxes are to be withheld. An employer of an employee must pay certain federal taxes and must collect federal taxes from its employees as well. The employer must withhold from its employees a certain percentage of its employees wages for income taxes. However, it must also withhold FICA taxes from the employee. These withholdings must be then paid to the federal government. The federal government also imposes FICA taxes on the employer. These taxes are the same in amount to the FICA taxes withheld from the employees. FICA taxes have two components; the first being Old Age, Survivor's and Disability Insurance (OASDI); and Medicare insurance. Both the employer and the employee must pay 7.65%, OASDI is 6.2% and Health Insurance is 1.45%, of the employee's income for these taxes, for a combined total of 15.3%. The employer is also responsible for collecting and paying over the employee's state taxes.
The status of a worker as an employee of a company rather than an independent contractor is important for determining who is to pay the FICA tax. If the worker is considered an independent contractor, then the employer would not withhold any taxes from the independent contractor's payments. The employer would provide the independent contractor with gross sums. An independent contractor is not subject to payroll taxes or to wage withholding taxes. An independent contractor has independent tax obligations which are similar to the FICA taxes. This is a Self-Employment Tax which consists of the OASDI and Medicare, for a total of 15.3%. An independent contractor, however, is able to have an income tax deduction for one-half of the self-employment taxes payable, giving the independent contractor a slight advantage over an employee's FICA taxes because the independent contractor's self-employment tax is on the worker's net wages rather than the employee's gross wages. To govern these relationships the IRS requires the employer of the Independent Contractor to submit a 1099 tax form to the IRS and the Independent Contractor reflecting its payments to the Independent Contractor. The Independent Contractor is to maintain its own records and file its forms independently.