Rebecca Muse, CPA
John K. McGill, JD, MBA, CPA
According to the United States Department of Labor, the misclassification of employees as independent contractors is a common problem facing employers, employees, and our economy.
In 2014 alone, the Wage and Hour Division of the Department of Labor uncovered more than $79 million in back wages were rendered to more than 109,000 workers across various industries.1 With staggering statistics such as this, how should employers address the classification of workers as independent contractors or employees?
How does the IRS define an independent contractor and employee?
As a general rule, the IRS defines an independent contractor as an individual for whom the employer has the right to control or direct the result or completion of the work but not what will be done and how it will be done.2 On the other hand, the IRS supports that when the employer can control how the work is to be done, the employer has entered into an employer-employee relationship.
However, most employment relationships are not that simple. To address the various facts and circumstances, the IRS issued Rev. Ruling 87-41 to help employers narrow the gap between what constitutes an employee and an independent contractor. Commonly referred to as the "20 Factor Test," each of the listed points in the rule is considered a guideline as to when an individual should be considered an employee. These are the most compelling of the 20 factors commonly used to support an employer-employee relationship:
• Instructions-Is a worker required to comply with the employer's instructions about when, where, and how to work?
• Training-Is the worker required to attend meetings and trainings at the employer's place of business regarding the completion of the work to be performed?
• Integration-Is the worker integrated in the enterprise within the ordinary course of business? Is the employee subject to the direction and control of the employer?
• Continuing relationship-Is there a continuing relationship between the worker and the employer?
• Set hours of work-Does the employer arrange the worker's scheduled hours of work?
How to avoid misclassifying a worker
To better understand the nature of your working relationships with hired-out or temporary workers, it is imperative that you look at the entire working relationships and assess your level of control over the work to be completed. If you are maintaining control over when the worker starts and ends work, how the work is completed, and more, you are likely entering into an employer-employee relationship, and you should obtain the proper documentation (Form I-9) and issue the individual a Form W-2 for the year.
If you're seeking independent contractor status, when using a temporary staffing agency, ensure the worker is classified as an employee of that agency and pay the agency directly versus paying the worker. It is also advisable to maintain a contract with both the hiring agency and the individual that clearly states the nature of the working relationship.
The consequences of misclassifying a worker can be substantial, such as incurring additional payroll taxes, interest, and penalties for your practice. A doctor might be able to reduce these charges if he or she is able to document that there is a reasonable basis for treating the workers as independent contractors, or if the misclassification was unintentional.
If you're worried that you might have misclassified a worker, do not hesitate to reach out to an Elliott Davis Decosimo advisor. We can assist with completing the IRS Voluntary Settlement Program, which is a voluntary disclosure program set up to help employers if the issue is not under an IRS audit.
1. California court rulings send clear message to employers who misclassify workers as 'independent contractors' [news release]. San Francisco, CA: United States Department of Labor Wage and Hour Division; August 18, 2015. http://www.dol.gov/opa/media/press/whd/WHD20151324.htm. Accessed Jan. 5, 2016.
2. United States Congress Joint Committee on Taxation. Present Law and Background Relating to Worker Classification for Federal Tax Purposes. (JCX-26-07) https://www.irs.gov/pub/irs-utl/x-26-07.pdf. Published May 7, 2007. Accessed Jan. 5, 2016.
Rebecca Muse, CPA, provides accounting and CPA services through Elliott Davis Decosimo PLLC, affiliate of the McGill & Hill Group, a one-stop resource for tax and business planning, practice transition, legal advice, retirement plan administration, CPA services, and investment advisory services. Visit mcgillhillgroup.com for more information.
John K. McGill, JD, MBA, CPA, provides tax and business planning exclusively for the dental profession and publishes the McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC.