When hiring a person, it is vital to determine whether the person can be classified as an independent contractor or an employee. Many factors determine that, which we discussed in this article. In this guide, however, we will focus on the IRS 20 Factor Test and how it can help employers and employees understand the worker status and classify it correctly.
Who is considered an independent contractor
An independent contractor is a service provider who agrees with an employer to provide requested services on a need or project basis. This individual is not directed or controlled by the employer regarding the performance of their work.
Independent contractors have greater control over how and when they carry out their work comparing to employees. Companies don't provide payments for the worker's business expenses, just a lump sum fee for their services.
Various laws apply to the employer-employee relationship that are generally not applicable to independent contractors. Pension, workers' compensation, social security, and wage and hour law are some of the things that cannot be offered to an independent contractor. However, independent contractors can be awarded a bonus. When it comes to tax withholding, employees are not obliged to withhold federal, state, and local taxes. Independent contractors are usually responsible for filing their own taxes.
There are many benefits to the independent contractor relationship, but every company must determine if this relationship is applicable carefully. The risk of misclassification is tremendous and can result in back taxes or premiums, civil fines, interest, and other retroactive damages.
The IRS created guidelines to help the employer to classify their employment relationships correctly. The IRS follows the common law test when determining whether an individual is an employee for federal employment tax purposes.
The Reasonable Basis test
The "Reasonable Basis" test serves as an excellent tool for employers, which prevents the IRS from challenging the status of an individual as an independent contractor if certain conditions are met. In that case, the employer does not have a tax liability for workers under Section 503, and the IRS cannot penalize them for misclassification.
- An individual has always been treated as an independent contractor by the employer.
- The employer has filed all returns for the individual for all periods after 1978, and the independent contractor status was consistent.
- The employer had a reasonable basis for treating an individual as an independent contractor by either relying on judicial precedent, published rulings, a prior IRS audit showing no penalties assessed for similarly situated individuals, or a longstanding recognized practice of a significant segment of the industry in which the individual worked.
The IRS designed the 20-Factor Test to help employers assess whether a worker is considered an employee or an independent contractor. No one factor is more important or indicative of employee status. It would be best if you looked at things holistically. If there are more "Yes" answers than "No," then there is a significant risk of employment relationship presence.
If an employer is unsure even after taking the test, we advise pursuing the IRS ruling. This is done by filing a Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to the IRS.