In mid-December, 2009, Senator John Kerry introduced a bill in the Senate that focuses on employers misclassifying workers as independent contractors. The bill, called the Taxpayer Responsibility, Accountability, and Consistency Act of 2009 (S.2882), would amend Section 530 of the Revenue Act of 1978.
The “safe harbor provision” of Section 530 gave businesses some leeway in classifying workers as independent contractors for employment-tax reasons. If certain requirements were met and the business had a “reasonable basis,” it could treat an individual as an independent contractor without having to resort to the IRS’ 20-factor common-law test.
But that could change with Kerry’s proposed legislation. Under the Taxpayer Responsibility, Accountability, and Consistency Act, a business would have a “reasonable basis” for classifying a worker as an independent contractor (and not be held to the common-law test) only if it met these two new standards:
1) The employer didn’t treat any worker in a substantially similar position as an employee since December 31, 1977
2) The independent contractor classification was based on a written statement from the Department of Treasury that the worker was not an employee, or on an IRS examination that concluded the worker was not an employee
The bill would also require you to issue a Form 1099 to anyone your business pays more than $600 annually, in addition to giving workers classified as independent contractors the right to obtain a determination of their status from the Secretary of the Treasury.
So what’s your status, Gladys?
If a worker is classified as an employee, you are required to withhold income taxes, and pay Social Security, Medicare and unemployment taxes. With independent contractors, however, you do not have these same obligations.
Yet if you misclassify an employee as an independent contractor, you may pay dearly down the road.
Basically, the questions in the IRS’ common-law test fall under three categories:
1) Behavioral control – Does your business direct or control how a person’s work is done through instructions, training or other means?
2) Financial control – Do you direct or control the business aspects of a person’s job, such as reimbursing expenses or providing supplies?
3) Type of relationship – What is the relationship between your business and the worker, such as written contracts or employee-type benefits like insurance and vacation pay?
In most cases, if your level of control extends to what is done by an individual – as well as how it is done – then that worker is an employee and not an independent contractor. An independent contractor, as a sole proprietor, directs many aspects of the business relationship.
Getting this right is critical – and could become more so under the Taxpayer Responsibility, Accountability, and Consistency Act. Misclassify a worker and you could be looking at a substantial tax bill and penalties from the IRS. There’s also the possibility of a misclassified independent contractor suing you for not providing the necessary overtime, meal periods or rest breaks that an employee would receive.