Year-End Planning: Who is an employee?

In case you hadn’t guessed it, it’s tax planning season (seriously though, we’ve mentioned it here and here). With this year-end planning comes a need to look at the reporting requirements related to your organization and its employees.

The IRS is a BIG fan of forms and there are several reporting requirements you’ll need to consider as you come to year-end and tax time. We’ll dive into some of the more specific forms in later blogs, but for now we want to take the opportunity to address a vital question you need to answer in order to begin your fantastic form filling journey.

That question is: Do you have employees or independent contractors?

Seriously?

Yep. The business relationship between the organization (you) and the person performing the services must first be analyzed to determine how payments should be treated.

Fine, tell me more.

An employee-employer relationship is generally determined by the “common law” test. The common law test focuses specifically on determining who has the right to control two basic elements:

  1. What must be done – i.e., the results of the work
  2. How it must be done – i.e., the method by which the work or services are performed

A worker is considered an employee (and subject to payroll tax withholding) if the employer has the right to control both aspects of the test. In other words, the employer controls both the results of the work AND how it must be performed.

A worker is considered an independent contractor if they can only control or direct the result of the work and not the method used to accomplish it.

Common law test

Are there other factors that can be used?

The IRS uses three categories when determining employee status and the degree of control and independence:

  • Behavioral control: factors that illustrate there is a right to direct or control how the worker performs specific tasks in which he/she is engaged. These include: significant degree of instruction, an evaluation systems to measure and ongoing training.
    • If these items are present, it generally points to an employer/employee relationship.
  • Financial control: factors that illustrate a right to direct or control the economic aspects of a worker’s activities. These include: does the person have a significant investment in the facilities or tools used in performing the service? Does the worker choose to incur expenses and bear their cost impact? Does the worker make themselves available to the general public?
    • If the answer to any of these questions is yes, they must be treated as an independent contractor.
  • Relationship of the parties: how do the worker and the business perceive each other in terms of their intent concerning control? Factors include: intent of the parties/written contracts, providing employee benefits, permanency of the relationship and if an individual’s services are a key aspect of the regular business of the organization.

 Seems pretty straightforward. But I’m guessing it’s not …

You’re correct. The common law test can be difficult to apply to specific cases or situations. Proper application of the test requires an employer to consider several factors of the work to determine if an employer-employee relationship exists.

Let’s break it down. The two primary characteristics that typically indicate an individual is an employee are:

  1. The employer has the right to discharge the worker
  2. The employer supplies the worker with tools and a place to work.

On the other hand, individuals such as lawyers, physicians, and contractors who offer services to the general public in the pursuit of an independent trade, business, or profession normally are not considered employees.

In case you hadn’t guessed it yet, it’s still not this simple. No one set of factors is the supreme answer. All the facts and circumstances in a particular situation have to be taken into account in determining whether an individual is an employee or an independent contractor. If you find yourself second guessing whether or not to treat someone as an employee or an independent contractor, Form SS-8 (yay forms!) can be filled out to assist in the decision.

Why do I need to figure this out again? Can’t I just ignore it?

Nope. Determining what type of individuals you’re using is necessary for filling out tax forms. If you have employees, their payments will be reported on Form W-2. If you have independent contractors, they’ll be reported on Form 1099-MISC.

Don’t worry, we talk more about these two forms here and here.

 

 

 

 

3 comments on “Year-End Planning: Who is an employee?

  1. […] must send out W-2 forms to each of its employees (if you need a refresher on who is an employee, go here) to whom they pay a salary, wage or other form of […]

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  2. […] “Miscellaneous Income” is filed by a business for certain payments made to nonemployees (remember the difference?) in the course of trade or […]

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  3. […] to do with reporting worker wages and income: W-2 and 1099 (sound familiar? We talked about them here, here and […]

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