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A New Twist on the Worker Classification Debate

Dec 22nd 2015
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As accountants gear up for another heavy flow of 1099s, the notion of what truly defines an employee versus an independent contractor comes to light and the definitions continue to vary.

Most of the confusion is due to the nature of household employment itself because families and their employees are generally not tax and payroll experts. When families consult with an expert, the narrative is always to reference IRS Publication 926 and explain how the IRS views a worker to be an employee if the family is controlling the working relationship.

However, recently, the US Department of Labor weighed in on this topic and provided some additional ammunition for tax experts to use when consulting families on why their household employee is not an independent contractor. There were six different areas they focused on, but two of them really stood out for household employees – permanence and economic dependence.

Permanence refers to the structure of the job. A household employee takes a job knowing she'll work for the family indefinitely. The only way the job stops is if she quits on her own, or if the family lays her off or fires her. None of these scenarios are things that are expected when a household employee accepts the job.

An independent contractor, on the other hand, is generally someone who is working short-term or for a defined period of time for a client and then moves on. This is also the logic behind a family giving a household employee an employment contract during the hiring process versus receiving a contract from an independent contractor.

Economic dependence is exactly what it sounds like. A domestic worker would be considered an employee because that person is economically dependent on the family for her financial well-being. This holds true for most nannies, senior caregivers, personal assistants, and other household employees because they're usually working for one family often enough where having a second job just isn't feasible. An independent contractor would have numerous clients, so if one fell through, she wouldn't be affected enough long-term for it to really matter. That person could, in theory, just go out and get another customer.

You may be asking yourself at this point: â€œDoesn't this just apply to full-time household employees? What about temporary workers?” Remember, these two points are just part of the broader picture of what makes a household worker an employee.

If a nanny knows up-front that she's only working for 12 weeks during the summer, she is still probably financially dependent on that job. A senior caregiver working part-time for two families is still working for those families indefinitely. And don't forget that the family is most likely controlling how the job is done, the hours worked, days worked, etc., in both of these scenarios. That means the IRS would most likely view the worker as an employee just on that factor.

At the end of the day, the thing to take away is that, in just about every instance, a household worker should be treated as an employee and receive a W-2 to file her taxes. Going the independent contractor route is illegal for the family, more expensive for the employee (because she has to pay twice as much in Social Security and Medicare taxes), and denies her of crucial benefits like unemployment insurance.

So, is it more work to do things by the book in accordance with IRS Publication 926? Of course. But at the same time, it's the right thing to do and will keep families from making a potentially expensive mistake down the road.

More and more state agencies are actually looking for instances of worker misclassification. The Department of Labor allocated funds last year to 19 states to ramp up enforcement. Several others have signed Memorandums of Understanding pledging to proactively investigate businesses or individuals filing Form 1099 to ensure the form isn't being used as a vehicle for tax evasion.

As we get closer to peak tax season, it's important to drive this point home to your clients who may have a household employee. The phrase, “an ounce of prevention is worth a pound of cure” definitely comes into play here. Setting up payroll and taxes at the beginning of the year is a lot easier than working backwards at the end of the year.

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