The IRS announced last week that the Tax Exempt and Governmental Entities Division will be targeting inappropriate worker classifications in its fiscal year 2021 compliance initiatives. The review of worker classification issues will ensure that exempt organizations are not incorrectly treating employees as independent contractors—resulting in underreporting and underpayment of taxes, and improper exclusion from retirement plans.
Background. Worker classification as either an employee (a worker dependent on another’s business for work) or independent contractor (a worker in business for themselves) is based on the degree of control and independence the worker has from the employer based on all information and evidence about the relationship between the parties and the circumstances surrounding the worker’s performance of services. Over the years, courts have relied on different factors to analyze the relationship between a worker and an employer, which fall into three main categories:
- Behavioral Aspects. Does the employer control and direct the work, or does the worker determine how best to accomplish a given task or goal? The ability to assign tasks and dictate the appropriate way to achieve them points toward an employee relationship. Conversely, an independent contractor will have the power to accept or decline tasks and make the decisions as to how to accomplish those taken on.
- Financial Aspects. Does the worker or the organization decide how the worker is paid? Is the worker eligible for expense reimbursement? Does the worker provide their own tools and supplies? Does the worker control the amount of profit or loss they will incur on the project? Again these factors indicate the degree of control or independence of the worker.
- Relationship Formalities. Is the worker eligible to participate in employee benefit plans such as retirement plans and insurance? Is the worker entitled to vacation time? Is there a contract formalizing the role of the worker? Does the worker have a continuing relationship with the organization and is the work performed a key aspect of the organization’s activities? Evidence of the central role or necessity of the work and ability to participate in benefits alongside employees tends to indicate an employment relationship.
It is important to note that some factors may point toward employee status and others toward independent contractor status, and some factors found to be determinative in some court cases may not be relevant to others at all. The key is to look at the entire relationship between the organization and the worker and document each aspect of the relationship used in making the decision as to a worker’s classification. In light of the new compliance initiative, this will be especially necessary for any organization that wishes to have its classification of workers as independent contractors respected.
For further guidance on IRS worker classification, click here.
Note: This post has been edited. The original version contained a discussion of a Department of Labor proposed regulation that contained a new independent contractor test based on two “core factors,” which has been withdrawn.