A hot topic these days is whether a worker is an independent contractor or an employee. This issue arises both in the labor and tax fields, and it is not a simple matter. In the workplace, the problem often arises when someone applies for unemployment compensation benefits. In Pennsylvania, someone who is an independent contractor is not eligible for unemployment compensation benefits and is considered to be self-employed.
Pennsylvania courts use a two-part test to make this distinction. Is:
(1) whether the worker was free from control and direction in the performance of the job; Y
(2) if the business is one that is habitually engaged in as a trade or independent business.
If the alleged employer objects to a claim for benefits based on an independent contractor’s defense, the alleged employer generally has the burden of proving that the worker was not an employee.
In determining whether a worker is free from the control and direction of an employer in the performance of work, Pennsylvania courts frequently consider and weigh eight factors.
1) How was the work done? Does a worker set their own hours, create their own work/task schedule, and/or decide how many other workers are needed for a particular task?
2) If there was a fixed rate of payment, who decides the cost of services provided and who decides when/if increases are granted. The amount of money a worker earns is not significant in the analysis.
3) Are taxes deducted from the worker’s wages or is a W2 or 1099 issued?
4) Does the prospective employer provide the necessary tools to carry out the services it provides?
5) Does the prospective employer offer on-the-job training?
6) Were there regular meetings with the alleged employer?
7) If the company goes bankrupt, will the worker only lose his job or will he have the responsibility to satisfy the possible creditors of the company? Does the worker work exclusively for one employer or is he free to accept other jobs at the same time?
Ultimately, all of the above factors can be boiled down to two words: the first is FREEDOM. Does the worker have the freedom to set his own hours, to set his own rate of pay, to compete with the company? The second is RESPONSIBILITY. Does the worker pay their own taxes, use their own tools, and/or bear the risk and burden of financial loss in the business?
In general, under IRS regulations, a worker is considered to be an independent contractor rather than an employee if the employer has the right to control or direct only the result of the work and not the means or methods by which the results are achieved. . A worker is classified as an employee if the employer has the right to control what will be done and how the services will be performed.
IRS regulations focus on
(1) relationship of the worker and the company,
(2) the degree of control that the company exercises over the worker, and
(3) the degree of independence of the worker.
The IRS also has specific regulations for certain jobs and salespeople, drivers, and others who don’t usually work in an office and has additional criteria for determining whether federal taxes should be withheld. In some cases, although W 2 versus 1099 are provided, some taxes do not need to be withheld and the worker can still deduct some expenses.
The IRS seeks to qualify as many workers as possible as employees rather than independent contractors, so taxes can be collected. IRS regulations take behavioral control, financial control, and the type of relationship of the parties into account when making this analysis. Many of these factors are the same as those discussed above in the context of unemployment compensation, so they will not be repeated. Other factors that are considered in determining the relationship between a worker and an employee are: whether there is a written employment contract; if the worker receives any benefits such as insurance, pension plan, vacation pay or sick pay; and whether there is a finite end date for the employment of the relationship.
If a worker is misclassified as an independent contractor instead of an employee, the employer will be liable for all payroll taxes, but if the employer has a reasonable basis to misclassify a worker, it will not be liable. Such relief is only provided if the employer filed all required federal information returns consistent with the treatment of the worker, such as showing that all workers in a substantially similar position were classified in the same manner.
Companies should consider reviewing their current payroll practices. Documentation and record keeping procedures should be reviewed and updated if necessary. Even if the employer determines that a worker is misclassified, the employer may still be entitled to a partial exemption from federal payroll taxes if he participates in the Voluntary Classification Settlement Program (VCSP). There are specific requirements for participation that I will not delve into here. Suffice it to say that the issue of employee classification is very complicated and growing.