Summary of Federal Laws
Tax
Tax Issues Related to Employment
Independent Contractor
26 U.S.C. § 3401(a) and 26 U.S.C. § 3402(a)(1)
If an employee is mistakenly classified as an independent contractor and the employer has no reasonable basis for doing so, the employer may be held liable for employment taxes for that worker. See IRS Publication 15A, Employer's Supplemental Tax Guide.
Revenue Ruling 87-41 (1987-1 C.B. 296) sets forth the 20 common factors indicating the existence of an employment relationship. For a summary of the 20 factor test see IRS Common Law Rule and Twenty Factors published by the Controller's Office at Wellesley. See IRS Publication 1779 Employee Independent Contractor Brochure for a summation of the more recent test which focuses on three factors: behavioral control; financial control; and the relationship of the parties. For an in-depth (160 pages) document on the same topic see Training Materials for IRS Examiners on Worker Classification (1996)
See Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1996), aff'd on reh'g, 120 F.3d 1006 (1997), cert. denied, 118 S. Ct. 899 (1998), mandamus granted, Vizcaino v. United States District Court for the Western District of Washington, No. 98-71388,1999 U.S. App. LEXIS 9057 (9th Cir. May 12, 1999), cert. denied, 68 U.S.L.W. 3432 (2000). In Vizcaino, the court held that certain workers were employees and not independent contractors, even though the employer had required them to sign agreements acknowledging their independent contractor status and waiving their claims to company benefits (including stock in Microsoft). In the May 12th, 1999 ruling, the court granted a writ of mandamus affirming its earlier ruling that any common law employee of Microsoft was entitled to stock options (subject to exceptions provided for in the benefit plan). The court made it clear that employees of temporary agencies can also be employees of Microsoft at the same time, for purposes of the common law employee test.
The Small Business Job Protection Act of 1996 strengthened the availability of relief under I.R.C. § 530, which protects taxpayers from employment tax liabilities even where they had mistakenly classified workers under the common law test. Under Section 530, a taxpayer may treat a worker as an independent contractor unless there is no reasonable basis for such treatment (certain conditions apply). Section 530 protection is strengthened by clarifying that Section 530 applies without regard to a worker’s classification under the 20-factor common law test, requiring the IRS to inform taxpayers of their potential Section 530 protection, creating a safe harbor for any industry practice shared by one-fourth of the relevant industry, and placing the burden of proof in these cases on the IRS once the taxpayer establishes a prima facie case for its classification.
Guidance on Payments to Clinical Research Subjects:
There has been some confusion over the years as to whether Form 1099 reporting is required on payments made to clinical research subjects. In 2005, an IRS e-mail response to a question posed by a taxpayer said that no reporting was required because the subjects are not in a trade or business. This conclusion was criticized because whether Form 1099 reporting is required does not depend on whether the recipient is in a trade or business. In 2008, the IRS clarified this position and said that, assuming the amount of the payment is $600 or more, Form 1099-MISC reporting is required and that the payment should be reported in Box 3 to avoid creating the presumption that the payments are subject to self-employment tax. Also in 2007, the IRS issued a Program Manager Technical Assistance memorandum that seems to back away from a strict Box 3 reporting position and suggests that Box 7 reporting may be appropriate if the individual is in a trade or business.
The IRS has now resolved any lingering ambiguity on this reporting issue by clearly stating in the instructions to Form 1099-MISC that Box 3 should be used to report “[a] payment or series of payments to individuals for participating in a medical research study or studies.” (See http://www.irs.gov/pub/irs-pdf/i1099msc.pdf). So, the reporting rules in this area now appear to be settled – an institution need not make an independent determination as to whether a clinical research subject is engaged in a trade or business of being a research subject and can safely report all payments made to research subjects in Box 3 of Form 1099-MISC, the box used for payments made to non-independent contractors. (text on this topic posted with permission of Tax Attorney Bertrand M. Harding, Jr., Editor of the College and University Tax Report)
Recordkeeping: The employer must retain the IRS form 1099-MISC, the information return. Form 1099-MISC must be filed with the IRS if the employer makes payments to independent contractors in the amount of $600 or more during the year. See I.R.C. § 6041(a). A copy of same must be provided to the independent contractor by January 31 of the following year. If an employee is misclassified as an independent contractor, the employer may also be liable for violating record retention requirements that relate to employees. Form SS-8 "Information for Use in Determining Whether a Worker is an Employee for Federal Employment and Income Tax Withholding" is a form an employer may use to determine worker status. The form has a series of questions about the work to be performed, and how the work will be accomplished. If this form is used, retain copies of this as well. This form is also available online at www.irs.gov under the forms section.
Resources
Employee Misclassification: Improved Coordination, Outreach and Targeting Could Better Ensure Detection and Prevention August 2009 GAO Report: GAO was asked to review the extent of misclassification.
Contract Review Information for CUA Faculty and Staff
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IRS Notice 989 (Rev. 7-2009) Commonly Asked Questions When IRS Determines Your Work Status is *Employee*
Aimed at the taxpayer, not the Employer.
Joint Committee Report on Worker Classification Issues: Describes present law and background of law on independent contractor versus employee issue. Report issued May 8, 2007.
Questions and Answers:
Question: It is legally permissible for the same individual to be an employee and an independent contractor of the University?
Answer: The individual would have to be performing different duties and the individual's relationship with the University would have to be fundamentally different as regards the independent contractor duties. Nonetheless, it is legally permissible.
Question: Are there risks to having the same individual be both an employee and an independent contractor in the same year for the same employer?
Answer: Treating an individual as an employee and as an independent contractor in the same year is risky for a University. See the audit guidelines published by the IRS in 1993 (Announcement 93-2) in anticipation of the high priority given in 1994 to college and university audits. The guidelines instruct auditors, "Employment arrangements should be carefully examined to determine if the institution has properly classified its workers as 'employees' or 'independent contractors.'" In a commentary on this instruction, the IRS notes that, "The IRS will closely examine individuals receiving both a Form W-2 and a Form 1099 within the same taxable year." Thus, if the University is subjected to a payroll audit, you should assume that all situations where individuals receive both a Form W-2 and a Form 1099 will be closely examined by the auditing agent.
Question: What is the nature of the risk?
Answer: The risk to the University is the uncollected "employment taxes" (i.e., income tax and FICA withholding). If the IRS issues an assessment against the University for these uncollected taxes (plus penalties and interest), the University has no choice but to pay the assessment (after exhausting administrative appeals). On employment tax cases, filing a case in the U.S. Tax Court before paying the tax is not an option.
CUA Policy
The Catholic University of America has determined its policy as follows: "No employee of the University may also be treated as an independent contractor of the University for any purpose without the prior written authorization of the University's General Counsel. Further, whether anyone can be hired as an independent contractor is determined by the General Counsel's Office."
Questions and Answers Courtesy of Thomas Arden Roha, Esquire, Roha & Flaherty
Washington, D.C. Attorney Roha serves as tax counsel for The Catholic University of America.
updated 5/7/09 mlo to check links and add compliance partners
updated mlo 5/12/09 to add ext on clinical researchers
compliance box links updated 6/9/09 rab
updated 6/21/09 to related policy and link for CUA faculty and staff on contracts; mlo
updated 8/27/09 to add IRS Notice 989
Last Revised 22-Sep-09 11:38 AM.
