IRS 20-factor test employee vs contractor
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This document discusses the issue of worker misclassification and outlines tests used to determine whether a worker is an employee or independent contractor. It notes that misclassification can result in fines and penalties for employers and denial of benefits and protections for employees. The IRS 20-factor test and economic realities test are described as ways to assess control and economic dependence to determine worker status.
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IRS 20-factor test employee vs contractor
- 1. Misclassification 1099 Contractor or Employee
- 2. Agenda • Why is this a big deal for employers? – Increased attention and resources – Fines and Penalties • Knowing the difference isn’t always easy – What is an employee? An independent contractor? • Tests to determine status – IRS -20 factor test assesses degree of control – Economic Realities test
- 3. Misclassification as Independent Contractors - Serious Problem • Affected Employees – Denied access to benefits and protections • FMLA, minimum wage, unemployment insurance • Employers – Fines and Penalties • Economy – Losses to the Treasury, Social Security and Medicare funds, Unemployment and Workers’ Compensation funds
- 4. DOL Misclassification Initiative • Under VP Biden’s Middle Class Task Force • Memorandum of Understanding between DOL and IRS 9/2011 • Additional MOU’s – Employee Benefits Security Admin – OSHA – OFCCP – Office of the Solicitor – 13 States (so far)
- 5. MOU Missouri/Illinois • The Wage and Hour Division entered into agreements with the Illinois and Missouri with the specific and mutual goals of providing clear, accurate, and easy-to-access outreach to employers, employees, and other stakeholders, and of sharing resources and enhancing enforcement by conducting joint investigations and sharing information consistent with applicable law.
- 6. 2011 Misclassification Collections 300 Additional Investigators $5 million recovered 7800 Affected workers 500% Increase since 2008 CBS Morning Show, December 2, 2011
- 7. Scope of Suggested Misclassification Areas • 2009 Government Accountability Office studies suggest 10-30 percent of firms misclassify. • High Risk industries sited – construction, janitorial, home health care, child care, transportation and warehousing, meat and poultry processing, and other professional and personnel service industries – Construction highest area sited in all studies
- 8. Committed Resources • The administration's budget request for fiscal year 2011 included $25 million for the Department of Labor as part of this initiative, including $12 million for increased enforcement of wage and overtime laws in cases where employees have been misclassified • The 2011 budget included 1582 FTE’s to investigate • The 2012 budget requested an additional 107 FTE’s
- 9. Recent Penalties Assessed • US Labor Department sues Kentucky cable, telephone and Internet installer to recover unpaid overtime wages, damages for 165 employees – Investigations found Bowlin Services LLC and Bowlin Group LLC misclassified employees as independent contractors, falsified payroll records – The amount of back wages and damages owed continues to accrue while the employer remains out of compliance with the law.
- 10. Recent Penalties Assessed • US Labor Department finds Knoxville, Tenn., security company owes $62,000 in back wages to 34 guards misclassified as independent contractors – DOL found the employees were improperly classified as independent contractors and consequently denied minimum wage and overtime wages due under the Fair Labor Standards Act.
- 11. Addition to CA Labor Code • Effective 1/1/12, additional penalties between $5,000 and $15,000 for each violation plus civil penalties already permitted by law. • The misclassified employee can seek up to three years worth of unpaid wages, unreimbursed businesses expenses, and penalties • California business owners may also face exposure to tort liability for injuries suffered by employees when workers compensation insurance was not secured, for unfair business practices, and even potential criminal liability under Labor Code §3700.5.
- 12. Reasons for Misclassifications • Need to make factual determinations – Present law requires an examination of a variety of factors that often do not result in a clear answer. • Misclassification may also be deliberate – both for tax and nontax reasons – Worker: contribute on a deductible basis to a pension plan or to deduct significant work-related expenses – Service recipient: avoid coverage & nondiscrimination requirements applicable to qualified retirement plans by classifying lower-paid workers as independent contractors.
- 13. Independent Contractor Definition • Independent contractors, by definition, – self-employed – not covered by employment, labor, and related tax laws. • Whether or not a worker is covered by a particular employment, labor, or tax law hinges on the definition of an employee.
- 14. IRS states that… • Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be - • An independent contractor • An employee (common-law employee) • A statutory employee • A statutory nonemployee
- 15. IRS states that… • An independent contractor – The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. – The earnings of a person who is working as an independent contractor are subject to Self- Employment Tax.
- 16. IRS states that… • An employee (common-law employee) – Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.
- 17. IRS states that… • Additional IRS categories include – A statutory employee – A statutory nonemployee • Both have their own set of criteria. So how do you determine where your workers fall?
- 18. Common-law Rule • Previously referred to as the 20-factor rule. • Identified over the years by the courts. • 1987 IRS developed the list • Not all inclusive • Determined on a case-by-case basis
- 19. The 20-Factors 1. Instructions 12. Payment by the hour, week, or month 2. Training 13. Payment of business and/or traveling 3. Integration expenses. 4. Services rendered personally 14. Furnishing tools and materials 5. Hiring, supervision, and paying 15. Significant investment assistants 16. Realization of profit or loss 6. Continuing relationship 17. Working for more than one firm at a 7. Set hours of work time 8. Full time required 18. Making service available to the general 9. Doing work on employer’s public premises 19. Right to discharge 10. Order or sequence test 11. Oral or written reports 20. Right to terminate
- 20. Economic Realities Test In addition to considering the degree of control the employer exercises, it takes into account the degree to which the workers are economically dependent on the business.
- 21. Test Description Laws under which test has been applied by Courts Common-law Employment relationship exists • Federal Insurance Contributions Act test (used by if employer has right to control • Federal Unemployment Tax Act IRS) work process, as determined • Income tax withholding by evaluating totality of the • Employment Retirement and Income circumstances and specific Security Act factors • National Labor Relations Act • Immigration Reform and Control Act Economic Employment relationship exists • Fair Labor Standards Act realities test if individual is economically • Title VII dependent on a business for • Age Discrimination in Employment Act continued employment • Americans with Disabilities Act • Family & Medical Leave act Hybrid test Employment relationship is • Title VII evaluated under both common- • Age Discrimination in Employment Act law and economic reality test • Americans with Disabilities Act factors, with a focus on who has the right to control the means and manner of a worker’s performance.
- 22. In Summary • Why is this a big deal for employers? ▫ Increased attention and resources ▫ Fines and Penalties • Knowing the difference isn’t always easy ▫ What is an employee? An independent contractor? • Tests to determine status ▫ IRS -20 factor test assesses degree of control ▫ Economic Realities test
Hinweis der Redaktion
- Employee Misclassification as Independent ContractorsThe misclassification of employees as something other than employees, such as independent contractors, presents a serious problem for affected employees, employers, and to the entire economy. Misclassified employees are often denied access to critical benefits and protections – such as family and medical leave, overtime, minimum wage and unemployment insurance – to which they are entitled. Employee misclassification also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers compensation funds.
- The Department’s Misclassification Initiative, launched under the auspices of Vice President Biden’s Middle Class Task Force, is making great strides in combating this pervasive issue and to restoring these rights to those denied them. In September 2011, Secretary of Labor Hilda L. Solis announced a major step forward with the signing of a Memorandum of Understanding (MOU) between the Department and the Internal Revenue Service (IRS). Under this agreement, the agencies will work together and share information to reduce the incidence of misclassification of employees, to help reduce the tax gap, and to improve compliance with federal labor laws.Additionally, labor commissioners and other agency leaders representing thirteen states have signed MOUs with the Department’s Wage and Hour Division, and in some cases, with its Employee Benefits Security Administration (EBSA), Occupational Safety and Health Administration (OSHA), Office of Federal Contract Compliance Programs (OFCCP), and the Office of the Solicitor. The Department is actively pursuing MOUs with additional states as well.
- $5 million in back wages for 7800 affected employees. An increase of 500% since 2008
- An August 2009 Government Accountability Office (GAO) report noted that the precise extent of misclassification is unknown, but studies suggest that it may affect 10 to 30 percent of firms. A number of recent studies conducted by, such as the National Employment Law Project and the Brennan Center, by researchers on behalf of state governments, and by the Department’s Employment and Training Administration, suggest that misclassification—while occurring in many industries—is prevalent in several high-risk industries: construction, janitorial, home health care, child care, transportation and warehousing, meat and poultry processing, and other professional and personnel service industries.
- UNITED STATESDEPARTMENT OF LABOR Wage and Hour Division (WHD)Press ReleasesU.S. Department of LaborWage and Hour DivisionRelease Number: 12-400-ATL (097) Date: March 20, 2012Contact: Michael D'Aquino or Michael WaldPhone: (404) 562-2076 or (404) 562-2078US Labor Department sues Kentucky cable, telephone and Internet installer to recover unpaid overtime wages, damages for 165 employeesInvestigations found Bowlin Services LLC and Bowlin Group LLC misclassified employees as independent contractors, falsified payroll recordsCOVINGTON, Ky. -- The U.S. Department of Labor has filed a lawsuit seeking back wages and liquidated damages for 165 employees of Bowlin Group LLC and Bowlin Services LLC for alleged violations of the federal Fair Labor Standards Act. The department’s suit was filed following investigations by its Wage and Hour Division that found the defendants had misclassified employees as independent contractors, and violated the FLSA by denying overtime compensation and failing to maintain accurate time and payroll records. The department also is requesting a permanent injunction against the companies to prevent future FLSA violations.Bowlin Group LLC maintains its principal office in Walton and operates five subsidiaries. One of these subsidiaries is Bowlin Services LLC, which performs installation services primarily under contract to Insight Communications, a cable, telephone and Internet provider in Kentucky. “Our investigators found that 165 hardworking employees – including many who had been misclassified as independent contractors – were required to work long hours but were illegally denied overtime compensation,” said Oliver Peebles III, administrator of the Wage and Hour Division’s Atlanta Regional Office. “Misclassification seriously harms employees by forcing them to shoulder additional costs such as payroll taxes and the full costs of any fringe benefits. This lawsuit puts employers on notice that we will not hesitate to take legal action to enforce the law.” After conducting employee interviews and reviewing the company’s records, the division found that some installers were classified as employees but other installers, doing the same work, were classified as independent contractors. All installers, regardless of their classification, were paid based upon the pieces of equipment they installed rather than at an hourly rate. They were thereby denied overtime compensation, which would have been at least one and one-half their regular rates of pay for hours beyond 40 hours in a week. In addition, the employer failed to keep accurate records of the number of hours worked by each installer and falsified payroll records to minimize the numbers of hours worked. The amount of back wages and damages owed continues to accrue while the employer remains out of compliance with the law. These investigations were conducted by the division’s Louisville District Office. The department is represented in court by its Regional Office of the Solicitor in Atlanta. The solicitor’s Nashville Branch Office filed the lawsuit in the U.S. District Court for the Eastern District of Kentucky, Jury Division, located in Covington. The misclassification of employees as independent contractors is an alarming trend, particularly in industries that often employ low-wage, vulnerable workers and in which the Wage and Hour Division historically has found significant wage violations. The practice is a serious threat both to employees entitled to good and safe jobs, as well as to employers who obey the law. Too often employees are deprived of overtime and minimum wages, and forced to pay taxes that their employers are legally obligated to pay. Honest employers have a difficult time competing against scofflaws. The Labor Department is committed to ensuring that employees receive the pay and benefits to which they are legally entitled, and to level the playing field for employers that play by the rules. The FLSA requires that covered employees be paid at least the federal minimum wage of $7.25 for all hours worked, plus time and one-half their regular rates, including commissions, bonuses and incentive pay, for hours worked beyond 40 per week. Employers also must maintain accurate time and payroll records. The FLSA provides that employers who violate the law are liable to employees for their back wages and an equal amount in liquidated damages. Liquidated damages are paid directly to the affected employees. Accessible and searchable information on enforcement activities by the U.S. Department of Labor is available at http://ogesdw.dol.gov/search. For more information on the FLSA and other federal laws administered by the Wage and Hour Division, call the division’s toll-free helpline at 866-4US-WAGE (487-9243) or its Louisville office at 502-582-5226. Information is also available at http://www.dol.gov/whd. Solis v. Bowlin Group LLC Civil Action File Number 2:12-cv-00076 ###U.S. Department of Labor releases are accessible on the Internet at www.dol.gov. The information in this news release will be made available in alternate format (large print, Braille, audio tape or disc) from the COAST office upon request. Please specify which news release when placing your request at (202) 693-7828 or TTY (202) 693-7755. The Labor Department is committed to providing America’s employers and employees with easy access to understandable information on how to comply with its laws and regulations. For more information, please visit www.dol.gov/compliance. U.S. Department of LaborFrances Perkins Building 200 Constitution Avenue, NW Washington, DC 202101-866-4-USWAGETTY: 1-877-889-5627Contact Us
- UNITED STATESDEPARTMENT OF LABOR Wage and Hour Division (WHD)Press ReleasesU.S. Department of LaborWage and Hour DivisionRelease Number: 11-1769-ATL (003) Date: Jan. 9, 2012Contact: Michael D'Aquino or Michael WaldPhone: (404) 562-2076 or (404) 562-2078US Labor Department finds Knoxville, Tenn., security company owes $62,000 in back wages to 34 guards misclassified as independent contractorsKNOXVILLE, Tenn. -- Custom Security Solutions Inc. has agreed to pay $62,038 in back wages to 34 security guards after an investigation by the U.S. Department of Labor's Wage and Hour Division found the employees were improperly classified as independent contractors and consequently denied minimum wage and overtime wages due under the Fair Labor Standards Act.Custom Security Solutions provides guard services for Premium Coal Co. at its mining sites and washing and loadout plants in Anderson, Scott and Campbell counties. "Increasingly, employers are categorizing their employees as independent contractors to avoid paying them in compliance with the FLSA, as well as other federal, state and local statutes," said Sandra Sanders, director of the Wage and Hour Division's Nashville District Office. "Misclassification costs taxpayers millions of dollars each year in uncollected employment taxes, and gives unscrupulous employers an unfair advantage. The Wage and Hour Division is vigorously pursuing corrective action in those situations when workers are, in fact, employees, to ensure that they are paid required wages and level the playing field for employers who play by the rules." The division's investigators determined that the 34 employees were paid a "straight time" rate for all hours worked instead of time and one-half their hourly rates for hours over 40, as required by the FLSA. This practice resulted in the employees being owed $61,937 in overtime back wages. Additionally, one of the employees was not paid the minimum wage of $7.25 per hour for all hours worked, and is also owed $101 in minimum wage payments. In addition to paying the back wages, the company agreed to maintain future compliance by ensuring employees are properly classified and compensated for all hours worked in accordance with the FLSA. The misclassification of employees as independent contractors is an alarming trend, particularly in industries that often employ low-wage, vulnerable workers and in which the Wage and Hour Division historically has found significant wage violations. The practice is a serious threat both to employees entitled to good and safe jobs, as well as to employers who obey the law. Misclassified employees often are deprived of overtime and minimum wages, and are forced to pay taxes that their employers are legally obligated to pay. Misclassification also creates a competitive disadvantage for employers who comply with the law. Under the FLSA, an employment relationship must be distinguished from a strictly contractual one. An employee – as distinguished from a person who is engaged in a business of his or her own – is one who, as a matter of economic reality, follows the usual path of an employee and is dependent on the business that he or she serves. For more information, visit http://www.dol.gov/whd/regs/compliance/whdfs13.htm. The FLSA requires that covered employees be paid at least the federal minimum wage of $7.25 per hour for all hours worked, plus time and one-half their hourly rates of pay for hours worked beyond 40 per week. Additionally, accurate records of employees' wages, hours and other conditions of employment must be maintained. For more information about the FLSA, call the Wage and Hour Division's Knoxville Area Office at 865-545-4619 or its toll-free helpline at 866-4US-WAGE (487-9243). Information also is available on the Internet at http://www.dol.gov/whd. ###U.S. Department of Labor releases are accessible on the Internet at www.dol.gov. The information in this news release will be made available in alternate format (large print, Braille, audio tape or disc) from the COAST office upon request. Please specify which news release when placing your request at (202) 693-7828 or TTY (202) 693-7755. The Labor Department is committed to providing America’s employers and employees with easy access to understandable information on how to comply with its laws and regulations. For more information, please visit www.dol.gov/compliance. U.S. Department of LaborFrances Perkins Building 200 Constitution Avenue, NW Washington, DC 202101-866-4-USWAGETTY: 1-877-889-5627Contact Us
- Effective January 1, 2012, Sections 226.8 and 2753 have been added to the California Labor Code authorizing California's Labor and Workforce Development Agency to assess civil penalties of not less than $5,000 and not more than $15,000 for each violation in addition to those civil penalties already permitted by law. The civil penalties increase to $10,000 and $25,000 for each violation if the Agency determines that the employer has engaged in a pattern, or practice, of willful misclassification of its employees as independent contractors. The new law further authorizes an individual to file a complaint with the Labor Commissioner and the Labor Commissioner to assess the above-mentioned civil penalties against the employer if the Labor Commissioner determines that the employer has in fact misclassified the employee. If the employer is a licensed contractor, the new law further requires the agency to notify the CSLB, and requires the CSLB to initiate its own action against the contractor.In addition to any fines or penalties assessed by either the IRS or a state agency, the misclassified employee can seek up to three years worth of unpaid wages (including overtime and meal and rest break violations), unreimbursed businesses expenses, and penalties for violating various California Labor Code provisions. See, Labor Code §203, §210, §226.3, §2802 and §3710.1; and California Unemployment Insurance Code §§1112, 1113 2, and 2118). California business owners may also face exposure to tort liability for injuries suffered by employees when workers compensation insurance was not secured (Labor Code §3706), for unfair business practices (Business and Professions Code §17200), and even potential criminal liability under Labor Code §3700.5.
- B. Reasons for Misclassification of WorkersNeed to make factual determinationsA major source of the confusion regarding classification of a worker as an employee oran independent contractor is that present law requires an examination of a variety of factors thatoften do not result in a clear answer. Although the proper classification of a worker often will beclear, in close cases the law creates a significant gray area that leads to complexity, with thepotential for inadvertent errors and abuse.Misclassification of workers also may be deliberate. In some cases, workers and servicerecipients may prefer to classify workers as independent contractors, both for tax and nontaxreasons. For example, the worker may wish to take advantage of the ability to contribute on adeductible basis to a pension plan or to deduct significant work-related expenses. A servicerecipient may wish to avoid administrative problems associated with withholding income andemployment taxes. The service recipient also may wish to avoid coverage and nondiscriminationrequirements applicable to qualified retirement plans by classifying lower-paid workers asindependent contractors. The IRS may have an interest in classifying workers as employees, inorder to obtain the compliance benefits of mandatory withholding.
- Refer to information on Statutory Employee and Nonemployee categories located in Publication 15-A, Employer's Supplemental Tax Guide (PDF) for additional information.
- Over the years courts have identified on a case-by-case basis various facts or factors thatare relevant in determining whether an employer-employee relationship exists. In 1987, basedon an examination of cases and rulings, the Internal Revenue Service (“IRS”) developed a list of20 factors that may be examined in determining whether an employer-employee relationshipexists.5 The degree of importance of each factor varies depending on the occupation and thefactual context in which the services are performed; factors other than the listed 20 factors mayalso be relevant.The 20 factors identified by the IRS are as follows:1. Instructions: If the person for whom the services are performed has the right to require compliance with instructions, this indicates employee status.2. Training: Worker training (e.g., by requiring attendance at training sessions) indicates that the person for whom services are performed wants the services performed in a particular manner (which indicates employee status).3. Integration: Integration of the worker’s services into the business operations of the person for whom services are performed is an indication of employee status.4. Services rendered personally: If the services are required to be performed personally, this is an indication that the person for whom services are performed is interested in the methods used to accomplish the work (which indicates employee status).5. Hiring, supervision, and paying assistants: If the person for whom services are performed hires, supervises or pays assistants, this generally indicates employee status. However, if the worker hires and supervises others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, this indicates independent contractor status.6. Continuing relationship: A continuing relationship between the worker and the person for whom the services are performed indicates employee status.7. Set hours of work: The establishment of set hours for the worker indicates employee status.8. Full time required: If the worker must devote substantially full time to the business of the person for whom services are performed, this indicates employee status. An independent contractor is free to work when and for whom he or she chooses.9. Doing work on employer’s premises: If the work is performed on the premises of the person for whom the services are performed, this indicates employee status, especially if the work could be done elsewhere.10. Order or sequence test: If a worker must perform services in the order or sequence set by the person for whom services are performed, that shows the worker is not free to follow his or her own pattern of work, and indicates employee status.11. Oral or written reports: A requirement that the worker submit regular reports indicates employee status.12. Payment by the hour, week, or month: Payment by the hour, week, or month generally points to employment status; payment by the job or a commission indicates independent contractor status.13. Payment of business and/or traveling expenses. If the person for whom the services are performed pays expenses, this indicates employee status. An employer, to control expenses, generally retains the right to direct the worker.14. Furnishing tools and materials: The provision of significant tools and materials to the worker indicates employee status.15. Significant investment: Investment in facilities used by the worker indicates independent contractor status.16. Realization of profit or loss: A worker who can realize a profit or suffer a loss as a result of the services (in addition to profit or loss ordinarily realized by employees) is generally an independent contractor.17. Working for more than one firm at a time: If a worker performs more than deminimis services for multiple firms at the same time, that generally indicates independent contractor status.18. Making service available to the general public: If a worker makes his or her services available to the public on a regular and consistent basis, that indicates independent contractor status.19. Right to discharge: The right to discharge a worker is a factor indicating that the worker is an employee.20. Right to terminate: If a worker has the right to terminate the relationship with the person for whom services are performed at any time he or she wishes without incurring liability, that indicates employee status.More recently, the IRS has identified three categories of evidence that may be relevant indetermining whether the requisite control exists under the common-law test and has groupedillustrative factors under these three categories: (1) behavioral control; (2) financial control; and(3) relationship of the parties. The IRS emphasizes that factors in addition to the 20 factorsidentified in 1987 may be relevant, that the weight of the factors may vary based on thecircumstances, that relevant factors may change over time, and that all facts must be examined.7Generally, individuals who follow an independent trade, business, or profession in whichthey offer services to the public are not employees. Courts have recognized that a highlyeducated or skilled worker does not require close supervision; therefore, the degree of day-to-daycontrol over the worker’s performance of services is not particularly helpful in determining theworker’s status. Courts have considered other factors in these cases, tending to focus on theindividual’s ability to realize a profit or suffer a loss as evidenced by business investments andexpenses.
- In essence, the economic realities test makes it harder to classify a worker as an independent contractor, because, in addition to considering the degree of control the employer exercises, it takes into account the degree to which the workers are economically dependent on the business. The economic realities test is used to determine employee status under the Family and Medical Leave Act (entitling workers to unpaid leave under certain circumstances), the Fair Labor Standards Act (establishing a minimum wage), and the Worker Adjustment and Retraining Act (providing for advance notice in event of plant closings and mass layoffs). Additionally, it is often applied by courts in determining independent contractor status in civil rights cases under Title VII of the Civil Rights Act, the Age Discrimination in Employment Act, and the Americans with Disabilities Act. States use a variety of other tests to determine independent contractor status for unemployment insurance purposes.19