The Employer/ Employee
Relationship
Kim Childress, CPP
February 18, 2012
What are your responsibilities as an employer?
Benefits of an Independent
Contractor Classification
• Less expensive for a business because
reporting requirements are less costly
– With a valid TIN – Form 1099 Misc (if contractor
was paid over $600 for services)
– No income, social security, Medicare, federal or
state unemployment taxes
– No administration of or contribution to employee
benefits
Common Law Test
• Classify by applying the ‘common law test’
– Right to control is KEY
• Control what work will be done and how that work will
be done, the employer-employee relationship exists
• Control Results to be accomplished and NOT the Details
of how = Independent Contractor
Common Law Test
• Key Control Factors
– Behavioral Control – Instructions and training
– Financial Control – Business expenses, investment,
public availability, pay basis, profit/loss potential
– Relationship of Parties – Written agreement,
benefits plan, open-ended relationship, key aspect
of services to business activity
Common Law Test
• Factors not important in the determination:
– Part time vs. full time work
– Location of work
– Hours of work
– Length of employment
Reasonable Basis Test
• Section 530 of the Revenue Act of 1978
– Court decision, IRS ruling/ technical advice/
private letter ruling
– Past IRS audit of employer
– Longstanding, recognized practice of employers
industry
– Consistent treatment since 1978
– Clarified by Small Business job Protection Act of
1996
Reasonable Basis Test
• Failure to file Form 1099-Misc in one year no
bar to Section 530 relief in later years
• Notice of Section 530 must be provided by IRS
• IRS auditors must be ‘liberal’ in applying
Section 530
Reasonable Basis Test
• Technical Services Specialists
– Tax Reform Act of 1986 – excludes ‘3 party’
arrangement technical service specialists
• Worker/ technical service firm/ firm’s client
– Status determined by common law test
– Includes: engineers, drafter, designers, computer
programmers, and systems analysts
Reasonable Basis Test
• Use Form SS-8 for a definitive ruling from IRS on
newly hired employee status
• While waiting for the ruling the employer should
treat the workers in question as employees, with all
appropriate wages and taxes reported and/or
withheld.
• If IRS rules the worker is an independent contractor
the employer is not entitled to a refund of any
employment taxes paid
Reasonable Basis Test
• Specific Industry Guidelines for:
– Entertainment Industry
– Limousine drivers
– Moving van operators
– Garment and furniture manufacturing
– Harwood timber industry
• Disputes can be heard by Tax Court
Statutory Employees
• Not employee under common law test
– Payments are not subject to federal income tax
– Payments are subject to social security, Medicare,
and federal unemployment taxes
– Employer’s share of Social Security and Medicare
taxes, and FUTA if applicable
Statutory Employees
• Four categories of statutory employees:
– Agent – drivers or commission drivers
– Full – time life insurance salespersons
– Home workers
– Traveling or city salespersons
Statutory Employees
• General requirements:
– Must agree with the employer that all services to
be performed personally by the worker
– Must not make a substantial investment in
business equipment or facilities
– Work must be part of a continuing relationship
with employer
Statutory Non-Employees
• Statutory non-employees are employees
under the common law test but are treated as
independent contractors
• Earnings are not subject to Federal income,
social security, Medicare, or unemployment
taxes
Statutory Non-Employees
• Two categories of statutory non-employees:
– Qualified real estate agents
– Direct sellers
• General requirements:
– Compensation directly related to sales/work
– Written contract that the individual will not be
treated as an employee for tax purposes
Temporary Help Agency Employees
• Hired, screened and trained by the temporary
help agency
• Employees of the temp agency
• Agency is responsible for complying with any
payroll, benefits and HR requirements
Leased Employees (PEO’s –
Professional Employer Organizations)
• Enter into a leasing arrangement
• Leasing company hires, trains, and qualifies workers
for a client
• Workers are employee’s of the leasing company
• Leasing company is responsible for all withholding &
employment taxes, administration and funding of
benefits
Watch Out
Make sure that the temp or leasing agencies are
financially secure and reputable before
entering into a contract. Since the agencies
financial failure could lead to the client
company to become liable for any withholding
or employment taxes that remain unpaid
Federal Wage – Hour law
• FLSA – U.S. DOL Wage and Hour Division
• Economically dependent on employer
• Factors considered:
– Control, profit, investment in tools/material,
special skills, permanency of relationship, if the
work is an integral part of employers business
State Income Tax Withholding
States that require withholding of state income
tax follow common law test used by the IRS in
determining whether an employer-employee
relationship exists.
Non-Resident Employees
• Employees live in one state and work in
another
• Some states have ‘reciprocity agreements’
• Check income tax withholding requirements
of the state you do business
State Unemployment Insurance
• Laws more inclusive than federal laws
• ‘ABC Test’ – Independent contractor if:
• Absence of control
• Business is unusual and or away
• Customarily independent contractor
• 34 states use A and/or B and/or C (remaining
states use Common Law Test)
IRS Enforcement and Penalties
• Worker Misclassification
– Employers that misclassify employees as
nonemployees or independent contractors face
substantial financial penalties as the result
• Penalties – Unintentionally Misclassifying
– Federal income tax = 1.5% if wages paid (3.0% if
no 1099 filed)
– Social security and Medicare tax = 20.0 % of
employees portion plus employers share (40.0% if
no 1099 filed)
IRS Enforcement and Penalties
• Intentional Misclassification Penalty
– Employer liable for full amount for Federal Income
Tax and 100% of the employee’s and employer’s
share of social security and Medicare
– Reclassification as an employee can mean
retroactive application of benefits such as 401(k)
and 423 stock purchase plans (Microsoft case)
IRS Enforcement Efforts
• 1099 Matching Program
– 1099 from one company only
– 1099 & W-2 from the same company
• Reclassification as an employee can mean
retroactive application of benefits such as
401(k) and 423 stock purchase plans
(Microsoft case)
Proof of Right to Work in U.S.
• Immigration & Reform Control Act of 1986
– Illegal to hire an unauthorized worker
– Employer must verify identity and eligibility
• Form I-9
– Employees complete Section 1 on first day of work
– Review documents and complete employers Section 2
within 3 business days of the date of hire
– Keep for 3 years from date of hire or 1 year from date of
termination
– Can not require specific documents
– Workers must present one from List A or one each from
List B and List C
Proof of Right to Work in U.S
Document Changes
Expired documents with no longer be
acceptable to prove identity or work
authorization
Proof of Right to Work in U.S.
• List A – Proof if Identity & Work Eligibility
– US Passport or US Passport Card
– Permanent Resident Card or Alien Registration Receipt
Card (Form I-551)
– Foreign passport with temporary I-551 stamp or
temporary I-551 printed notation on a machine
readable immigrant visa
– Employment Authorization Document that contains
photo USCIS Form I-766
– Foreign passport with an Arrival-Departure Record,
Form I-94 or I-94A
Proof of Right to Work in U.S.
• List B – Proof of Identity
– State issued drivers license or state ID with photo
– ID card issued by government agency with photo
– School ID card with photo
– Voter’s registration card
– US Military or military dependent ID card or draft
record
– US Coast Guard Merchant Mariner card
– Native American tribal documentation
Proof of Right to Work in U.S.
• List B – Proof of Identity
– Canadian Driver’s License
– For persons under age 18
• School record or report card
• Clinic, doctor, or hospital record
• Day care or nursery school record
Proof of Right to Work in U.S.
• List C – Proof of Work Authorization
• US Social Security Card
• Certificate of birth abroad, Form FS-545 or DS-1350
• Original or certified copy of birth with official seal
issued by state or local government
• Native American tribal document
• US Citizen ID card I-197
• Employment authorization document issued by DHS
(other that I-766)
Proof of Right to Work in U.S.
• Reverifying employment authorization for
current employees:
When an employee’s work authorization
expires, the employer must verify his/her
employment eligibility. If the employee can’t
provide the employer with proof of current
work authorization that individual cannot
continue to be employed.
Proof of Right to Work in U.S.
• Penalties for knowingly hiring unauthorized
aliens
– 1st offense - $375 to $3,200 per employee
– 2nd offense - $3,200 to $6,500 per employee
– 3rd offense - $4,300 to $16,000 per employee
Proof of Right to Work in U.S.
• Penalties for knowingly hiring unauthorized
aliens
• Failure to comply with verification
requirements - $110 to $1,100 per person
• Pattern and practice of violating hiring and
verification process - $3,000 and/or 6 months
in jail
Proof of Right to Work in U.S.
What constitutes ‘knowingly’ hiring
unauthorized aliens?
Proof of Right to Work in U.S.
• Electronic Forms I-9
– Can be electronic if the form is legible, not
changes to name, content, or sequence of data
elements
– Electronic signatures attestations forms must be
completed
Employment Verification Pilot
Programs
• Illegal Immigration Reform and Immigrant
Responsibility Act of 1996
• 3 verification pilot programs
– Basic pilot – Became E-Verify
– Citizen Attestation Pilot (not renewed after 2003)
– Machine Readable Document Pilot (not renewed
after 2003)
What is E-Verify Program?
E-Verify Program - General Rules
• Employers can request
– All hiring in each state or
– Limited to hiring in one or more states or
– One or more places or hiring within a state
E-Verify – Program Rules
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Program is voluntary
Free to participating employees
Available on the internet
Internet training available
Two types of users
– Program Administrator
– General User
• Internet Resources
• Photo matching available
E-Verify – Program Rules
• A Memorandum of Understanding (MOU)
with the SAVE Program and SSA
• New Hires only
• Form I-9 completed
– Form I-9 requirements remain the same, except all
‘List B’ identity documents must contain a photo
– Verify within 3 days of hire
– All employees
E-Verify Program Rules
Federal contractors and subcontractors must
use E-Verify system to verify that new hires
and current employees working on certain
federal contracts are eligible to work in the US
IMAGE Program
• Employer Benefits
– Provide training & education on proper hiring
procedures, fraudulent documentation, and antidiscrimination laws
– Share data on illegal schemes
– Review hiring and employment practices
IMAGE Program
• Employer duties
– Company must agree to I-9 audit by ICE
– Use Basic Pilot employment verification program
for all new hires
– Establish internal training
New Hire Reporting
• Personal Responsibility and Work Opportunity
Act of 1996
• Facilitate collection of child support
• Uncover fraud and abuse
– Unemployment Compensation programs
– Worker’s Compensation Programs
– Public Assistance (Welfare) benefit programs
New Hire Reporting
• Reporting Requirements
– Employee name, address, and social security
number
– Date employee first performed services for pay
– Employer name, address, and FEIN
New Hire Reporting
• Employers operating in only 1 state
– Report new hire information to that state
• Paper, magnetically or electronically
• Multistate Employers
– Can report to any state
• Magnetically or electronically
New Hire Reporting
• Multistate – reporting in one state
– Notify Secretary of Health and Human Services
• HHS form, letter, fax or e-mail
• Information required:
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Employer name, address, phone and FEIN
Designated state and report begin date
List of all states with employees
Employer contact person
Any subsidiary name, zip code, and FEIN included in
the reporting
New Hire Reporting
• General Reporting Requirements:
• Report within 20 calendar days of hire
• Magnetically or electronically
– 2 transmissions per month (at least 12-16 days
apart)
• States can establish the time frames but they
can not be longer than the federal rules
New Hire Reporting
• General Reporting Requirements
• Multistate employers provide only information
required by the state they report to
• Date of hire
• Employees who work 1 day must be reported
• Independent contractors
New Hire Reporting
• General Reporting Requirements
– Rehired, Leave of Absence
• Temporary help firms
• Unions and hiring halls
– Employees
– Individual referred for employment
New Hire Reporting
• Reporting format and method
• Form W-4 or equivalent
• 1st class mail, fax, magnetically, or
electronically
• CAUTION: If you use a Form W-4 for reporting,
use a copy of the original when adding the
employers name, employee’s date of birth,
etc. Do not alter the original Form W-4!
New Hire Reporting
• Penalties
• Civil penalty of up to $25
• $500 maximum if the result of a conspiracy
between the employer and employee
New Hire Reporting
• Information Processing
– The states have 5 business days to enter
information to the State Directory
• 2 business days from the date of entry to transmit a
child support withholding order
• Within 3 days from the date of entry, the state
must furnish the information to the National
Directory