1. INDEPENDENT CONTRACTORS
OR COMMON LAW EMPLOYEE
GARY GARNER, EA

2. I.R.S. Circular 230 Disclosure:
To ensure compliance with requirements imposed by the IRS, we inform you that any
U.S. federal tax advice contained in this communication is not intended or written to
be used, and cannot be used, for the purpose of (i) avoiding penalties under the
Internal Revenue Code or (ii) promoting, marketing or recommending to another party
any transaction or matter addressed herein.

3. The Concern
Employee Classification Errors
Employee vs. Contractor

4. IRS
80% of contractors are misclassified
STATES
Income Tax Revenues
State Unemployment Tax Revenues

5. Contractors are unique in that they are:
A. Self Directed
B. Have clients not employers
C. Responsible for their own tax compliance

6. What will trigger and audit?
1. A former contractor files for unemployment benefits.
2. A competitor files a complaint.
3. The IRS and states have goals to audit a
certain percentage of businesses every year.
4. The IRS and states will target certain industries
and geographic locations.

7. Four Industries Considered Highest Targets
Construction Industry

8. Four Industries Considered Highest Targets
Technology

9. Four Industries Considered Highest Targets

10. Four Industries Considered Highest Targets

11. Independent Contractor
Pub 15/ Circular E
Common-Law Rules
To determine whether an individual is an employee or an
independent contractor under the common law, the
relationship of the worker and the business must be
examined. In any employee-independent contractor
determination, all information that provides evidence of the
degree of control must be considered.
Facts that provide evidence of the degree of control and
independence fall into three categories: behavioral
control, financial control, and the type of relationship
of the parties.

12. Independent Contractors
Degree of Control - 8 Common Law Factors
Custom
Skill Required
Furnishing of Tools
Control from premises
Length of time employed
Method of payment
Nature of occupation
Intent

13. Independent Contractors
Custom
The IRS considers the normal
practice for each industry.

14. Independent Contractors
Skill Required
The assumption is that
contractors normally provide
more highly skilled services.

15. Independent Contractors
Furnishing of Tools
The furnishing of tools,
equipment and materials
indicates an employment
relationship.

16. Independent Contractors
Control from Premises
This is called the Where,
When, and How rule. If we tell
the contractor where, when
and how this indicates an
employment relationship.

17. Independent Contractors
Length of Time Employed
Employment over a
considerable period with the
fact of full time hours worked
indicates an employment
relationship.

18. Independent Contractors
Method of Payment
Payment per hour, week or
month indicates an
employment relationship.
Payment per job indicates a
contractor relationship.

19. Independent Contractors
Nature of Occupation
If the work preformed is the
same or similar to the regular
activities of the employer this is
an indication of employee
status.

20. Independent Contractors
Intent
Although not determinative the
intentions of the parties in
entering into a relationship is
one factor to consider.

21. States Interest
States utilize the ABC Test
A = Control and Direction of Work
B = Outside Service
C = Independent Business or
Trade

22. Independent Contractors
State Issues
Test A Control and Direction of Work
1. Instructions and training
2. Set hours of work
3. Set schedule or routine

23. Independent Contractors
State Issues
Test B Outside Services
1. Outside the course of usual
business operations

24. Independent Contractors
State Issues
Test C Independent Business or Trade
1. Has a separate office or business
location
2. Financial investment in business
3. Has own liability and workers’
compensation insurance.
4. Possesses all the applicable business
licenses
5. Files business federal income tax
returns

25. Communication
between the IRS
and states

26. States Memorandum of Understanding
• Arizona, Arkansas, California, Colorado,
Connecticut, Hawaii, Idaho, Kentucky,
Louisiana, Maine, Massachusetts,
Michigan, Minnesota, Nebraska, New
Hampshire, New Jersey, New York, North
Dakota, Ohio, Oklahoma, Rhode Island,
South Carolina, South Dakota, Texas, Utah,
Vermont, Virginia, Washington, Wisconsin

27. Memorandum of Understanding
Goals
1. Increase compliance with 1099 filing
2. Increase collection of federal and state
income and unemployment taxes
3. Leverage state and federal resources
in improve compliance

28. Independent Contractors
Federal Voluntary Classification
Program
 Want to voluntary reclassify
certain workers as employees
for income tax withholding,
FICA, and FUTA tax purposes

29. Independent Contractors
Voluntary Classification
Program
 Have consistently treated
the worker as a
nonemployee

30. Independent Contractors
Voluntary Classification
Program
 Have satisfied the 1099 filing
requirements for the previous
3 years prior to filing to
voluntary disclose and
reclassify

31. Independent Contractors
Voluntary Classification
Program
 Have satisfied the 1099 filing
requirements for the previous
3 years prior to filing to
voluntary disclose and
reclassify
Firms can still qualify
if they have not filed
all 1099’s the previous
three years. They will
pay a higher penalty.

32. Independent Contractors
Voluntary Classification
Program
 Are not currently under audit
by the IRS or the Department
of Labor or a state government
agency for classification of
workers.

33. Penalties for Misclassification

34. Independent Contractors
Pub 15/ Circular E Page 9
Treating Employees as Non–Employees
You will generally be liable for social
security and Medicare taxes and withheld
income tax if you do not deduct and
withhold these taxes because you treated
the employee as a non-employee

35. Misclassification Consequences
Penalties
1.028% of pay up to $110,100 (2012)
.324% of pay over $110,100 (2012)

36. Section 530 Relief

37. Section 530 Relief
1.Reasonable Basis
2.Substantive Consistency
3.Reporting Consistency

38. Section 530 Relief
Reasonable Basis
1. Relied on a court ruling, IRS ruling, or IRS Technical
advice (SS-8)
2. IRS previously audited your business and did not
reclassify that type of worker
3. A significant segment of your industry customarily
treats this type of worker as an independent
contractor
4. Relied on some other reasonable basis such as a
CPA or attorney told you to treat the worker as an
independent contractor

40. 2. Financial Control
3. Type of Relationship

41. Section 530 Relief
Substantive Consistency
1. you (and any predecessor business)
must have treated the workers, and
any similar workers, as independent
contractors. If you treated similar
workers as employees, this relief
provision is not available.
2. 10 year look back

42. Section 530 Relief
Reporting Consistency
1. Finally, you must have filed all required federal tax
returns (including information returns) consistent with
your treatment of each worker as not being
employees. This means, for example, that if you
treated a worker as an independent contractor and
paid him or her $600 or more, you must have filed
Form 1099-MISC for the worker. Relief is not
available for any year and for any workers for whom
you did not file the required information returns.

48. Back Up Withholding
If contractor fails to provide a
valid Tax Identification
Number
We must withhold BACKUP
WITHHOLDING
28%

49. Back Up Withholding
Payments Subject to Backup
Withholding
•Rents
•Commissions
•Non-employee compensation for
services
•Interest
•Dividends

50. Back Up Withholding
Payees Exempt from Back Up
Withholding
Tax Exempt Organizations
Government Agencies
Corporations
Financial Institutions
Real Estate Investment Trusts

51. 1099 Rules
Not required for Corporations
TWO EXCEPTIONS TO THE CORPORATION RULE

52. Back Up Withholding Reported in Box 4

53. Medical and health care payments reported
in Box 6 even if they are incorporated!

54. We must report all payments to attorneys
over $600 even if they are incorporated

55. Failure to file 1099’s = $10,000 penalty
For every 1099 not filed that was
required = $500
Failure to File Penalties

56. Recommended Practices
1. Use an Independent Contractor Agreement
A. Termination Date
B. Define the project to be completed
C. Define the payment policies
D. Define the consequences of non completion
E. State that “responsible for own tax compliance”

57. 2. Obtain the independent contractor’s taxpayer
identification number.
3. File all required form 1099.
4. Request that the contractor issue invoices for
payment.
5. Allow the independent contractor to
determine when, where and how to complete
the work.
6. Use contractors who are incorporated.
Recommended Practices

58. THANK YOU FOR ATTENDING!
If you have additional questions
or comments please contact
gary@illuminaregroupinc.com
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