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“Independent Contractor” or “Employee” — The Stakes Now Become Even Higher

By Kenneth H. Bridges, CPA, PFS     December 2014

Companies frequently use contractors in lieu of “employees.”  It is an arrangement that can work well for both parties.  The contractor gets to maintain his or her sense of independence, may command a higher hourly rate and be able to have his own retirement plan, while the company for whom the work is performed avoids withholding and payroll taxes, does not have to include the contractor in its benefit plans, and avoids the sense of longer term commitment that may come with an “employee.”  The IRS and/or Department of Labor (DOL), however, sometimes disagree with the classification and challenge that an “independent contractor” is in fact an “employee.”  Such a challenge has always carried with it potentially very high stakes, as a determination that a worker is an employee rather than a contractor can subject the employer to back payroll taxes (plus penalties and interest) and benefit plan violations.  With the “employer mandate” provisions of the Affordable Care Act beginning to take effect in 2015 (i.e. employers with 100 or more employees must provide health insurance in 2015, and the number of employees drops to 50 in 2016), the stakes for misclassification become even higher.

Historically, the IRS used a “20-factor test” to determine whether a worker was an employee or an independent contractor.  In more recent years, however, the IRS has moved away from the 20-factor test to focus on three key factors: behavioral control; financial control; and relationship of the parties.  The DOL uses an “economic realities” test, which looks to whether the worker is economically dependent on the employer.

The Obama administration has made clear that worker classification is a priority issue, and has provided significant resources and funding for a Misclassification Initiative.  The states have been actively pursuing employers in this regard as well.  The IRS has implemented a Voluntary Classification Settlement Program which permits companies that meet certain criteria to voluntarily elect to reclassify the workers prospectively and limit the amount of payroll tax exposure for prior years.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.