Summary of Federal Laws
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Tax Issues Related to Employment
26 CFR § 31.3401(c) (employee defined)
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.
The IRS has strict standards for payment of parties as independent contractors. If it is a gray area, it is best to pay the person as an employee.
In order to qualify as independent contractors, the individual would need to meet the Internal Revenue Service (IRS) requirements. The IRS regulatory definition of “employee” is set forth in 26 CFR § 31.3401 (c) -1(b).
(b) Generally the relationship of employer and employee exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is not an employee.
Revenue Ruling 87-41 (1987-1 C.B. 296) sets forth the 20 common factors indicating the existence of an employment relationship. 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)
IRS INFO letter 2012-0069 (Sept. 24, 2012 to Hon. Frank R. Wolf) IRS Looks at whether a person can be an employee and an independent contractor of the same entity at the same time. IRS says such dual classification is possible and lays out the factors to be used in making this determination. The letter references Form SS-8, Determination of Worker Status for Federal Employment Taxes and Income Withholding, to requset an IRS determination of a worker's status. In instances where an individual provides services in two separate roles to the same business, the IRS examines separately the relationship between the worker and the business for each performance of services.
Section 530 Harbor
Given the severity of the penalties the IRS created a safe harbor (per Section 530 of the Revenue Act of 1978) for cases of misclassification. Meeting the safe harbor would not prevent an audit, but it could relieve the employer of some of the back taxes that would be triggered in the event an employee was paid as a contractor.
To meet the safe harbor, the following would have to be shown:
1. The employer consistently treated the workers (and any individuals holding a substantially similar position) as nonemployees for employment tax purposes for those tax periods and all prior tax periods after 1978.
2. The employer filed all returns required for the workers for those periods and all periods after 1978 and the returns were all consistent with nonemployee status; and
3. The employer had a reasonable basis for treating the workers as nonemployees.Reasonable basis is shown if the Employer’s treatment of the individual was in reasonable reliance upon any of the following:
1. Judicial precedent, published rulings, or technical advice or letter ruling to the taxpayer;
2. A past employment tax audit in which no assessment was made on account of improper classification of workers holding substantially similar positions; or
3. A long-standing recognized practice of a significant segment of the industry in which the worker worked.
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.
Twenty Question Test for Determining if Individuals serving the University are Employees or Independent Contractors: Customized for CUA by Thomas Arden Roha, Roha & Flaherty
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.
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.
Top 10 Tax Issues The Non-Tax Employment Lawyers Should Know NACUA Presentation From June 2012, by Nancy Farnam and Joseph Irvine. Available from NACUA Outline Directory.
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.
Question: University practice is to include all payments to an employee on the W-2, regardless of whether or not it is related to the specific job the employee is employed to do. Should the practice be changed to put the income that is "unrelated" on a form 1099 instead? Examples would include the following:
· Employees (students or faculty/staff) that we pay as a musician or a DJ at an event unrelated to their employment position with us;
· Priests that are employed by Catholic as staff or faculty that receive an honoraria to perform a mass for another area of the university;
· A person whose employment was terminated earlier in the W2 reporting year that is now receiving honoraria or payment from us for an unrelated job.
Answer:The University asks about a series of situations were a University employee serves the University in another capacity and the question is whether his/her service in that other capacity can be as an independent contractor. As a general rule, if an individual is a employee for one purpose, he or she is an employee for all purposes.
a. The IRS, when asked, has never ruled that an employee can be an independent contractor in a different line of work for the same employer.
b. If an employer submits a W-2 and a 1099 on the same individual, that can trigger an employment tax audit from the IRS.
c. If the IRS prevails on an employment tax issue, it has the power to assess a penalty on the institution, but also a personal penalty on the individual who was legally required to withhold income tax but did not, the penalty being equal to one hundred percent of the tax that should have been withheld, which is among the harshest penalties in tax law. The personal penalty was put in the tax law to support the integrity of the withholding system; the withholding system is the primary means by which the Federal government collects tax revenue, and they wanted to put in place a huge incentive for Treasurers, Controllers and others to enforce withholding.
Thus, the first two situations listed above involve University employees who serve the University in another unrelated position on an ad hoc basis. They should be treated as employees in their unrelated positions as well and their income for the unrelated position added to their W-2 wages and withholding be applied accordingly.
The situation of the former employee who receives honoraria for an unrelated position after the termination of his or he employment could be considered an independent contractor so long a his/her service passes the IRS's Twenty Question test (see below). If a W-2 and Form 1099 are filed in the same year, this may trigger an employment tax audit but paying a former employee as an independent contractor is justified if the former employee's service actually qualifies for independent contractor status. The IRS Twenty Questions must be consulted.
Note the threshold for filing a Form 1099 for an independent contractor is $600. If the total compensation is less than that amount, no Form 1099 need be filed.
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.
Question: I am dealing with part-time coaches (both head coaches and assistants) who want to be paid in two payments during the coaching season instead of twice a month. WV law requires that employees be paid at least twice a month. I have some questions for anyone who uses part-time coaches (who have no other job duties), especially anyone in WV. Are your coaches hired as employees or independent contractors? Does it make a difference if it's a head coach or an assistant? (I'm questioning thatan assistant coach qualifies as an independent contractor.) If they are employees, are they paid in the same manner as all other employees? I
can't find anything that would allow our coaches to be paid less than twice a month except by "special agreement" and then they have to be paid at least once a month.
Answer: I am unaware of any court authority or IRS administrative guidance that concludes an athletic coach as anything other than an employee (subject to income/employment tax withholding and reporting on IRS Form W-2).
Institutions have asked for clarification from the IRS over the years but the answer has consistently been that under the applicable facts, sufficient control is either exercised, or available to be exercised, by the institution so that the coach must be regarded as an employee and not an independent contract. Of course, it is a fact-intense test under the "20-Factor" review (IRS Rev. Rul. 87-41, 1987-1 C.B. 296), but every single ruling out there (at least that I have found) going back to the late 1960s all conclude that a coach must be regarded as an employee, whether it is a public/private, full-time/part-time, or an occasional/seasonal position. The rulings all dutifully march through a typical examination of the 20-factor test as applied to the facts at hand, then the IRS concludes that a coach is an employee. See: PLR 9352022 (October 1, 1993) (swim coach); PLR 9336042 (June 16, 1993) (golf); PLR 9308036 (December 1, 1992) (cheerleading); PLR 9308018 (November 25, 1992) (lacrosse); PLR 8835037 (June 7, 1988) (part-time/seasonal interscholastic coach); PLR 8134185 (May 29, 1981) (football); and this is just a few of the quite numerous rulings.
The control/relationship test can be found at Treas. Reg. 31.3121(d)-1(c)(2).
For example, here is the language from IRS Chief Counsel Advice, CCA 200206053 (Feb. 8, 2002):
"Question 14: A school district pays its coaches a fee for their services. Should the district report these payments on Form W-2 or Form 1099? Coaches are hired under a contract each season. The schedule of practice times, game times and locations is set by the athletic director of the school. The school provides equipment, referees, time keepers, insurance, medical coverage for the players, etc. The school provides transportation to games and liability insurance. It issues general instructions under which the coach works.
Answer: School coaches, like teachers, are subject to sufficient control that they are typically employees under the common law. The school district has a right to control the manner and means by which coaches and athletic directors perform their functions. We know of no case or ruling in which members of the faculty of a school or college were found to be independent contractors. Potter v. Commissioner, T.C. Memo. 1994-356.
A coach does not have the freedom of action characteristic of an independent contractor, but must function under policies and regulations established for the school. Additional important factors are that a coach has no investment in facilities, has no opportunity for profit or loss, is an integral part of the school's trade or business, and must perform his services personally. A coach performs his services on school property, on a schedule established by the school. Schools are liable for negligent or tortious conduct of their faculty members. The fact that a coach's remuneration is termed a "fee" or "stipend" rather than salary or wages is immaterial. Coaches' wages are subject to employment taxes and should be reported on Form W-2."
[internal citations to other cases and IRS administrative guidance/rulings omitted.]
Just be sure to consider the facts and the consistently articulated position of the IRS when evaluating whether your coach should be regarded as an employee for withholding/reporting purposes!
Answer courtesy of Sean Scally, Tax Attorney for Vanderbilt University
Global HR Hot Topic-Overseas Independent Contractor or de Facto Employee?: Cracking the Classification Conundrum July 2011 White and Case by Donald C. Dowling, Jr.
An excellent summary of the employment issues that arise with Global Education programs.
CCR updated CFR links 6/18/15