The Employer/ Employee
Relationship
Kimberley Childress, CPP
February 16, 2013
Benefits of an Independent
Contractor Classification
• Reporting requirements are less
– 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 and how = Employee
• 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
• 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
• 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 Penalties
• Unintentionally misclassifying employees as
independent contractor
• Penalties
– 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)
State Penalties
• The failure to withhold and pay over state
income taxes because of workers
misclassifications will result in back tax
assessments and penalties at the state level
1099 Matching Program
• 1099 from one company only
• 1099 & Form W-2 from the same company
• Employment Tax Examinations Program (ETE)
the IRS will concentrate on employers
suspected or workers misclassification, often
based on leads from other federal & state
agencies
Classification Settlement Program
(CSP)
• Allows examiners & businesses to resolve
workers classification cases as early in the
enforcement process as possible
• Examiner determines if the business is entitled
to Section 530 relief
• If entitled to Section 530 relief, no assessment
& the business can continue to treat the
workers in question as independent
contractors.
Voluntary Workers Classification
Settlement Program (VCSP)
• Permit employers to voluntarily reclassify
workers as employees for federal employment
tax purposes and obtain relief similar to that
obtained in the Classification Settlement
Program (CSP)
Eligibility for VCSP
• Consistently treated the workers as
nonemployees
• Must have filed all required Forms 1099 for
the previous 3 years
• Cannot currently be under audit by the IRS
• Cannot currently be under audit concerning
the classification of workers by the DOL or a
state government agency
Effect of VCSP
• Pay 10% of employment tax liability
• Will not be liable for any interest & penalties
• Will not be subject to an employment tax
audit for prior years
• Agree to extend the period of limitations on
assessment of employment taxes for 3 years
Application Process
• Must submit Form 8952 – Application for
Voluntary Classification Settlement Program
• Name a contact or authorized representative
with a valid Power of Attorney
Closing Agreement
• Enter into a closing agreement with the IRS to
finalize the terms of the VCSP
• Simultaneously make full & complete payment
of any amount due under the closing
agreement.
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.
• 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
Employment Verification 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)
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
• Photo Matching Tool Available
– Occurs automatically for a new employee who
presents an Employment Authorization Document
(EAD) or Permanent Resident Card (green card) to
prove work authorization
– Allows employers to compare identical phontos
against the images stored in USCIS’s databases
– Enhanced to allow photo matching of US
Passports and Passport Cards
E-Verify
• Driver’s License Information Matching Pilot
Program
– RIDE – Records and Information from DMV’s for EVerify
– Helps validate the authenticity of driver’s licenses
used by employees as Form I-9 identity
documents
– Matches the dates of birth and the driver’s license
numbers in state DMV records
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
• No employer cost
• Equipment required
– PC with modem and touch tone line with a single
originating phone number
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
– 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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–
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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