Independent Contractor vs Employee: The Battle Rages On
Whether a worker is classified as an "employee" or an "independent contractor" is a significant distinction to small businesses. Classifying workers as independent contractors rather than employees saves the employer considerable amounts of money.
If workers are classified as independent contractors, employers are not required to withhold and pay Social Security (FICA), Medicare, federal income taxes and unemployment insurance taxes (FUTA), all of which are estimated to exceed 20% of the employer's total payroll costs. Furthermore, additional savings are realized when voluntary benefits, such as overtime, and pension-profit-sharing plans, are excluded. Thus, small businesses are waging the war for liberal use of independent contractors.
On the opposite side of the battlefield is the Internal Revenue Service and the Illinois Department of Employment Security (IDES), both of which are out to stick aggressive employers with the penalties associated with falsely classifying employees as independent contractors. Most people would think that the IRS is the principal villain in this drama, but the real problems began about 10 years ago when the IDES received extra funding for auditing more employers to determine compliance with Section 212 of the Illinois Unemployment Insurance Compensation Act. Each year the IDES audits more and more businesses which use independent contractors.
Until 1986, employers were allowed to classify certain technical workers (e.g. engineers, designers, and programmers) as independent contractors. However, the 1986 Tax Act eliminated this so called "safe harbor" and the IRS established a common law test to determine if employees qualified as an independent contractor or an employee.
The IRS has listed 20 factors used to reclassify independent contractors as employees. The reasons most frequently used in court cases to classify workers as employees are:
- the employer instructs the worker in how, when, where and whether the work should be done;
- the worker must be trained before the job is started;
- the worker becomes substantially integrated into the employer's operations;
- the worker must personally perform the work rather than have it delegated to his or her employees;
- the employer has a continuing relationship with the worker;
- the hours of work are dictated by the employer;
- the worker works virtually full-time for you.
The IDES audit requires a business to prove:
- the business neither controls nor directs the worker's work;
- the worker's work is different from the employer's work or is performed at another location; and,
- the worker has an independently established business of his or her own.
A useful tool for the employer to use to protect itself is to review IRS Form SS-8 and use the questionnaire attached to this form. Although the IDES independent contractor test is stricter than the IRS "master and servant" test, the IRS questionnaire is useful to avoid some pitfalls in this area. For more information contact George Bellas.