Purpose: To provide guidance on properly classifying workers as employees or as independent contractors.
Under tax laws, a worker is an employee under the common law rules if the person for whom he/she works has the right to direct him/her in the way he/she works, both as to the final results and as to the details of when, where, and how the work is done. However, the employer need not actually exercise the control; it is sufficient that he has the right to do so. Where the employer does not possess that right, the individual is an independent contractor. A 20 factor common law test may aid in the determination of whether the requisite right of direction and control exists in a given situation.
The purchase of services by independent contractors should be established by completing an independent contractor agreement so that a firm contract is properly established before services are performed. If the independent contractor is an individual and a new vendor, a form W-9 - Request for Taxpayer Identification Number and Certification should be completed by vendors. The vendor should submit the completed W-9 with the invoice for payment. The returned W-9's will be used by the accounting department to fulfill the form 1099 reporting requirements if the total payment to the vendor per calendar year exceeds $600.00.
Reason for Policy
The IRS has expressed concern that many colleges and universities are classifying employees as independent contractors and, as a result, are failing to pay substantial amounts of employment tax. Additionally, Department of Labor issues can arise regarding qualified retirement plan participation. Service arrangements should be carefully examined to determine if the institution has properly classified its workers as employees or as independent contractors. While the law regarding employees and independent contractors has not changed, the IRS has recently given high priority to the correct classification of employment relationships and the tax implications of decisions made. The IRS has announced that its emphasis on employment relationships and tax reporting will continue in the future.
The purpose of this policy statement is to provide Drake personnel who have hiring responsibilities a basic understanding of IRS requirements and a procedure for ensuring that individuals hired or contracted to perform services are properly classified. Please note that payments made to most corporations, partnerships, and limited liability companies for services are not affected by this policy. (The exclusion may not apply to a business organization established for the purpose of receiving income for one individual.)
Employee: an individual who performs services that are subject to the will and control of an employer-both what must be done and how it must be done. The employer can allow the employee considerable discretion and freedom of action, so long as the employer has the legal right to control both the method and the result of the services.
Independent Contractor: an individual over whom the employer has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
Employer's Responsibilities: Employers are legally required to pay FICA, and withhold income tax on the wages of workers classified as employees. If the worker is legitimately characterized as an independent contractor, the payee, not the payer is responsible for employment-related taxes. The payer is responsible, however, for reporting to the IRS, on form 1099, non-employee compensation in excess of $600.
Penalties for Misclassification: If a worker is determined by the IRS to be an employee instead of an independent contractor, the employer could be responsible for paying any taxes that should have been withheld and were not, including federal income tax, social security tax (both the employer's and the employee's shares) and Medicare taxes, plus interest. In addition, penalties for failure to remit taxes due could apply. Note: no IRS penalties exist for classifying a worker as an employee in a case where an argument for independent contractor status could have been successfully argued.
Departments should review the process outlined below before making a commitment so payment to the worker will be properly classified and not delayed. The independent contractor determinations are subject to audits and any information provided would be made available to auditors and others as required.
Determining Correct Classification
Determining the correct classification is not an easy task. The IRS has provided a list of ì20 common law factorsî to assist in determining if the worker is an employee or an independent contractor. These factors are intended as guidelines, not as strict rules. In addition to these common law factors, two basic questions should help clarify the issue:
1. Does the University pay as employees others who perform essentially the same duties that are to be performed by this worker?
2. Has this worker previously been paid as an employee to perform essentially these same tasks?
If the answer to either of these two questions is yes, then the worker in question is considered to be an employee, and the person certifying the status need not proceed with the common law test. After reviewing the 20 common law factors, the departmental employee directly responsible for the work to be performed should determine whether the contract being reviewed either creates or is likely to be executed in a manner that could create an employer/employee relationship. If the worker does not pass criteria 1 and 2 of the 20 question test, they must be classified as an employee. If the relationship is unclear after analysis, a determination of employee should be established. The departmental employee who is required to certify the independent contractor/employee status may find it difficult to reach a definite determination and may need assistance. In such instances, help can be obtained by contacting the Controller's Office at 271-3112.
Once determination has been made, please complete the Drake Consultant Report and submit to Accounting.
Consultant Reports will be reviewed by Business & Finance to verify appropriate classification. Because departmental interpretation of the 20 rule test may be more liberal than the likely interpretation of an IRS agent, Business & Finance reserves the right to reverse any determination that is not clearly supported by the facts available. A hiring department will be notified if such a change is being made.
Contesting a Determination
If you feel that you have received an inappropriate determination from Business & Finance, you may ask the Controllerís Office to submit to the IRS a form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income tax Withholding. While waiting for the IRS determination, which may take months, the service provider will be paid as an employee. If the IRS determines the correct classification to be independent contractor, the taxes withheld will be remitted to the worker.
Following please find a copy of The Common-Law 20 Question Test.
The Common-Law 20 Question Test
1. Workerís availability to the general public - an independent contractor makes services available to the public on a regular and consistent basis. They can demonstrate they are actively seeking and soliciting this type of work from the general public. For example, they list their expertise in directories, seek referrals, and or market their practice.
2. Risk of profit or loss ó the IRS generally regards a worker to be an independent contractor if the worker can realize a profit or suffer a loss from performing services, while a worker who cannot realize a profit or loss is generally regarded as an employee. The IRS says, for example, that if a worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, this indicates that the worker is an independent contractor, but the mere risk that a worker will not receive payment for services, which is common to both independent contractors and employees, is not a sufficient economic risk to support treatment as an independent contractor.
***If worker cannot be justified as an independent contractor under criteria 1 and 2, no further review is needed; the worker must be paid as an employee.***
3. Personal service required - the right of an independent contractor to substitute another's services without the employer's knowledge shows that the employer is not requiring one individual's personal services.
4. Payment by the hour, week or month - an independent contractor is paid in a lump sum fee basis when the job is done. An invoice must be generated to substantiate the payment.
5. Employer's discharge rights - an independent contractor cannot be terminated as long as they are fulfilling the contract.
6. Worker's termination rights - an independent contractor could be held financially responsible for any loss the employer suffered because they did not fulfill their contract.
7. Continuing relationship - the relationship between an independent contractor and an employer ends when the job is done.
8. Compliance with instructions - independent contractors cannot be told when, where or how to do the job.
9. Set hours of work - the independent contractor establishes his/her own hours of work.
10. Training - independent contractors do not go through any type of instructional training period with a more experienced employee to learn how to do the job. Independent contractors specialize in the field in which you have employed them and do not need to be trained.
11. Working on the employer's premises - an independent contractor, unless the nature of the service requires, works off-premises.
12. Required work order or sequence - an independent contractor does not need to be told in what order to do the job. They have been contracted with as one that is an expert in this field and do not need to be told how to do the job.
13. Integration into business - the success or continuation of the business is not dependent on the independent contractor's performance of the service.
14. Control over hiring, supervising, and paying of assistants - an independent contractor maintains control of their assistants. The employer contacts the independent contractor if there is a problem, and the employer pays the independent contractor for the work done and then the independent contractor pays the assistants directly.
15. A full-time work requirement - an independent contractor has the availability to work for more than one client.
16. Working for more than one firm - an independent contractor has an established business in which they work for more than one firm.
17. Payment of business or travel expense - an independent contractor is responsible for his/her own business or travel expense. If paid by an employer, the employer must include in the independent contractor's 1099, unless you can verify an accountable plan.
18. Investment in facilities - if the independent contractor maintains an office on the employer's premises, he/she pays a rent or lease payment for the office space as well as overhead.
19. Furnishing of tools and materials - an independent contractor has the necessary tools and materials to do the job.
20. Required reports - an independent contractor is not required to submit oral or written reports.
Send policy comments to: Web Administrator
Responsibility for Administration: Vice President for Business and Finance
Department Policy Resides in: Business and Finance