The IRS and employers often disagree on the tax status of workers, but a recent Tax Court case helped clarify the issue, to some degree.
Typically, the employer claims a worker is an independent contractor, while the IRS classifies the laborer as an employee. When the matter ends up in Tax Court, as evidenced by a new case, Hampton Software Development, TC Memo 2018-87, 6/19/18, the particular facts and circumstances dictate the outcome.
The stakes for employers are high and if a worker is treated as an employee, the employer has to withhold federal income tax and the employee’s share of FICA tax from the wages. Also, the employer must pay its fair share of the FICA and federal unemployment tax (FUTA). For 2018, the FICA tax is 7.65 percent on wages up to $128,400 and 1.45 percent on wages above that amount.
Conversely, if a worker qualifies as an independent contractor, the employer isn’t responsible for federal income tax withholding and FICA and FUTA payments. And, perhaps even more important, it doesn’t have to provide expensive fringe benefits like health insurance and matching 401(k) contributions to those workers.
Although there are no absolute rules for determining the status of a worker, the IRS has established valuable guidelines. Generally, a worker doesn’t qualify as an independent contractor if he or she performs services that are controlled by the employer.
The factors indicating the degree of control usually fall into these three categories:
1. Behavioral: Does the employer control, or have the right to control, the worker? How about the way he or she does her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer?
3. Nature of relationship: Are there written contracts? Does the worker receive fringe benefits? Will the relationship continue after the project is completed?
In the new case, the employer acquired and placed in service a 60-unit apartment complex in Tulsa, Oklahoma in 2006. At the time of the acquisition, the worker was providing various services for the apartment complex to the former owner and he was retained by the employer.
As the owner and the operator of the apartment complex, the employer established the amount of rent that it charged for each unit. It also set the policies, rules, and/or regulations that applied at the apartment complex, such as policies on pets and rules or regulations governing the swimming pool. It maintained an office at the complex for various functions.
Among other jobs, the worker leased available units to tenants, collected rents, performed maintenance work and performed odds and ends. He had no real direct supervision from the employer.
However, the employer had the right to direct the worker’s performance if it chose to do so. It provided most of the tools the worker needed for the jobs. The worker was paid on a monthly basis and could be terminated by the employer at any time.
Based on these facts, the Tax Court determined mined that the worker should be classified as an employee, not an independent contractor, even though he essentially worked without supervision.
Make sure your clients are on firm ground if they treat workers as independent contractors rather than employees. Examine the key factors to make an assessment and document these aspects.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...