The IRS and HR: Who is an Employee?

by Michael Haberman on April 15, 2010 · 2 comments

Here is a little humor to start off TAX DAY.
A man is on his death bed and his best friend is there beside him. The man says to his friend “Fred, I want you to do me a favor. After I am dead and cremated I want you to put my ashes in an envelope and send them to the IRS. And on the outside of the envelope I want you to write a message.” Fred asks “What is the message?” The man answers “I want you to write NOW YOU HAVE EVERYTHING.”

On this TAX DAY I thought it appropriate to talk about the fact that the IRS exerts a great deal of control over a company or organization that Human Resources must pay attention to, not the least of which is defining who is an employee. The IRS looks at four catagories of people who deliver services to an employer. These include common-law employees, statutory employees, statutory non-employees and, of course, independent contractors. Here is a quick break down:

  • Common- Law employee: Under common-law rules, anyone who performs services
    for you is your employee if you have the right to control what will be done and how it will be done. Pretty simple.
  • Statutory employees: If workers are independent contractors under the common  law rules, such workers may nevertheless be treated as employees by statute, “statutory employees,” for certain
    employment tax purposes. These workers include some drivers, full-time life insurance agents, some home workers, and traveling sales agents who may sell goods for you and others.
  • Statutory non-employees: These include direct sellers, licensed real estate agents, and some companion sitters.
  • Independent contractors: These are people over which the employer does not exercise behavioral control or financial control and with whom they have a well-defined relationship.

Who is an independent contractor and who is not is frequently an area of confusion for many employers. While the IRS used to have a 20-factor test, today the more frequently look at the amount of control you have over the person’s behavior versus the outcome of their work. They look at how you pay the individual and whether they can work for anyone else at the same time. And they look at whether there is a written contract.
 
The quick and dirty rule is: If it looks like a duck, walks like a duck, quacks like a duck the IRS is going to consider it a duck. And if you have improperly classified your “duck” as a “non-duck” then you are going to owe back taxes and probably penalties for that “duck” and all like “ducks.”
 
Here is the IRS’s Publication 15-A Employer’s Supplemental Tax Guide that offers a pretty understandable definition of each of the catagories listed above, especially that of independent contractor. I would suggest you click on this link, download the document and read it. If you need further help here is a book that might be able to provide some further guidance. Surprisingly Simple: Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.

Given the aggressive agenda of enforcement that both the USDOL and the IRS have laid out for employers for the next couple of years it is important for HR professionals to understand the wage & hour issues and tax issues that inadverent misclassifications may cause.

You have been warned!

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