ASA Newsletter Article by Gretchen Kelly - Worker Classification: Getting it right
Posted 3-9-2011 | By Gretchen Kelly
As published in Volume 14, Issue 46 of the ASA-MN Newsletter
In recent months we’ve seen an increase in audits related to the misclassification of employees as independent contractors. The Government Accountability Office estimates that as many as 20 percent of employers misclassify employees as independent contractors. This has created a significant underpayment of employer taxes. The Internal Revenue Service (IRS), Congress and state unemployment agencies view this as a growing problem and are paying much more attention to the issue.
Some employers may classify employees as independent contractors to avoid employment related taxes such as Federal Insurance Contribution Act (FICA), Federal Unemployment Tax Act (FUTA), state unemployment insurance, as well as workers’ compensation insurance and other employment related benefits. But often, employers simply make mistakes when determining worker classification.
Generally, a person is a common-law employee if the employer has the right to control and direct the worker’s performance. An independent contractor, on the other hand, follows certain direction or control, but only as it relates to the results. The IRS, as well as many other agencies, provides guidance on determining worker status; however, every situation is unique and judgment needs to be used in evaluating the facts and circumstances. The IRS considers three types of control when evaluating whether an employee/employer relationship exists.
The first is behavioral control. Is the person required to comply with instructions about when, where and how to work; and/or, does the company have the right to control how the results are achieved? Examples include: what tools or equipment are used; where to purchase supplies or services; what routines or patterns must be used; what order or sequence to follow; and what reports are submitted.
The second is financial control. There is an expectation that an independent contractor assumes entrepreneurial risks. Examples include: an investment in their business; providing their own tools, materials and equipment; responsibility for making a profit or suffering a loss; providing services to the general public; and paying their own business and travel expenses.
The third is the relationship of the parties. Both the independent contractor and the company must perceive a business relationship rather than an employer/employee relationship. Also, consider whether or not the services provided are a key aspect of the business relationship, whether there is a continuing relationship and whether there is a written contract.
Employers should have a consistent process for determining worker classification and documenting the basis for reaching an independent contractor conclusion to be used in the event of an audit. We recommend a checklist containing the IRS factors. Below is a list of additional resources for further guidance.
Internal Revenue Services
Unemployment Insurance Minnesota - www.uimn.org/tax/hdbook/ind_contractor.htm
Minnesota Department of Labor and Industry - www.dli.mn.gov/ccld/ICECfaq.asp
For additional information, please contact Gretchen Kelly, CPA, CCIFP, at 651-407-5822 or gkelly@hlbtr.com.