By Traci M. Rutter
If your business has both employees and independent contractors, it can be very difficult to distinguish between the two categories. Not only has this been a hot-button issue for the IRS recently, but there are new considerations at stake as well with the passage of the Affordable Care Act (ACA).
Employee Versus Independent Contractor Classification
In order to determine whether payments you make for services are W-2 employee wages or Form 1099-MISC nonemployee independent contractor payments, employers should be analyzing the factors used by the IRS and developed by case law. Generally, the concept of “control” is most well known and very important, but there is a 20-Factor Test and 3 Categories that the IRS and courts will analyze in making a final determination.
The 20-Factor Test is based on facts and circumstances and is not a bright-line test. Further, in examining the degree of “control” an employer exerts over a service provider, the IRS will look at Behavior Control, Financial Control, and the Relationship of the Parties. Businesses must weigh these factors when determining whether a worker is an employee or independent contractor. Given the uncertainty inherent in such a subjective analysis, this presents potential tax risks to employers.
Greater Risks for Schools Now
Not only is it important for businesses to correctly classify employees versus independent contractor vendors in general to avoid potential tax penalties and failure to remit proper withholdings and payroll taxes, but this task can be even more complicated for schools and colleges that often use adjunct faculty and other part-time service providers that may be extremely difficult to classify under the factors and control tests.
Now, the ACA further adds another layer of danger, confusion, and potential liability for your business if you misclassify a worker as an independent contractor instead of an employee. Since the ACA health insurance and “shared responsibility” penalty provisions are determined based on numbers of full-time employees and full-time equivalent (FTE) employees, businesses may find themselves with unexpected ACA obligations and/or penalties if independent contractors are really deemed to be employees.
In addition to ACA benefits, misclassification can result in other employer legal and employee benefit liability consequences as well as it relates to which persons are subject to ERISA, FLSA wage and overtime provisions, workers’/unemployment compensation, benefit plan eligibility, etc.
Seek Guidance Now Regarding Potential Consequences and Solutions
The tax penalties and legal liability related to this issue can be significant. However, there are currently IRS voluntary disclosure programs and potential tax relief available to employer-taxpayers. In addition to documenting worker classification properly and correcting any misclassifications, tax planning in advance to ensure proper classification and W-2 and 1099 reporting can be a critical preventative step to mitigate risk and exposure.
As we anticipate the IRS and Department of Labor to increase their enforcement efforts in this area, especially related to ACA issues, we recommend consulting your McClintock & Associates’ tax advisor regarding potential exposure and solutions to help you mitigate any potential concerns.
Volume 1, Issue 4
Fall 2014