By Kelly A. Brennen
If your business has both employees and independent contractors, it can be very difficult to distinguish between the two categories. On July 15, 2015, the U.S. Department of Labor (DOL) issued a 15-page administrator’s interpretation memo regarding application of the misclassification of workers as independent contractors for purposes of the Fair Labor Standards Act (FLSA).
Federal DOL Clarification
The DOL’s new guidance explains that a 6-part “Economic Realities” test should be utilized to determine worker classification for purposes of the FLSA. Under this test, the important question is whether a worker is economically dependent on the employer, thus making the worker an employee versus whether the worker is truly in business for him or herself only. Determining the economic independence of a worker should occur on a case-by-case basis, using a multi-factor test that has been developed by a series of federal court decisions, and no one factor is determinative. The test includes the following six factors:
- The extent to which the work performed is an integral part of the employer’s business
- Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?
- How does the worker’s relative investment compare to the employer’s investment?
- Whether the work performed requires special skills and initiative
- Is the relationship between the worker and the employer permanent or indefinite?
- The nature and degree of control exercised or retained by the employer
The question now in most practitioners’ minds is “Does this change the IRS’ tax rules historically used for worker classification, employment tax withholding, W-2 versus 1099-MISC reporting, etc.?”
IRS Position
The IRS has yet to comment on the changes to the DOL’s position regarding the definition of independent contractor versus employee. The IRS’ has historically followed the common law general rules that focus on the degree of behavioral and financial CONTROL over the worker. In addition, the type of relationship is considered including such factors as the existence of a written contract, whether employee benefits are provided, the permanency of the relationship, and whether the worker provides services that constitute a key activity of the employer’s business.
Recommended Action
At this time, the IRS tax rules have not formally changed, however, we anticipate that the IRS will ultimately adjust its position to that which will bring in more tax revenue — and the DOL guidance tends to lead to greater employee classification (and hence more employment tax withholding for the IRS). In addition, the attention to this issue has further escalated since classifying and counting employees is a critical component of the health insurance provisions of the Affordable Care Act. As we anticipate the IRS and DOL to increase each agency’s enforcement efforts in this area, we recommend consulting your McClintock & Associates tax advisor regarding potential exposure as well as solutions to help you mitigate any potential concerns.
Volume 2, Issue 4
Fall 2015