Employee or Independent Contractor?
Prior to entering office, President Joe Biden issued a comprehensive labor plan. Within his plan was a call to enforce current laws against employers that misclassify employees as independent contractors.
Further in the plan was an endorsement of California's law that establishes a new test for independent-contractor status. To put it in perspective, California's test is so strict that soon after it became law, the legislature passed an amendment because of the public outcry. President Biden's labor plan calls for federal legislation that would make worker misclassification a substantive violation of federal labor, employment and tax laws with additional penalties beyond those imposed for other violations.
(Editor's Note: The House of Representatives passed the Protecting the Right to Organize (PRO) Act, HR 482, on March 9, and it awaits possible action in the Senate. The bill would redefine what constitutes an independent contractor and make it easier for employees to organize a union.)
Because of the nature of farming, this could have a huge impact on the industry. Although the test might change, I wanted to review independent-contractor classification. This isn't black or white; you need to look at the IRS and Department of Labor's (DOL) regulatory guidance, as well as case law to determine if a worker is an employee or independent contractor.
The common law test developed by the IRS uses 20 factors to determine if a worker is an employee or independent contractor. The IRS subsequently updated the employee/independent contractor test into three controlling factors: behavioral control, financial control and relationship control.
The behavioral control test boils down to the employer having control over the worker and how he or she accomplishes the job. Factors include the type of instruction given, degree of instruction, evaluation system and training. To sum it up, a person is an employee if the employer controls where/when he or she works, provides detailed instructions on how the work should be done, and provides detailed training and periodic feedback on how he or she is doing.
The financial control test looks at who bears the economic benefits and burdens of the workplace relationship. This test focuses on the employee side of the equation. Independent contractors typically make a significant investment, typically in equipment, in order to accomplish their jobs. They are more likely to have unreimbursed expenses and may incur a loss in the business relationship. An independent contractor also tends to have a separate place of business, advertises and has the ability to work for others. Another sign of being an independent contractor is irregular pay -- that is, compensation is not paid weekly, biweekly or monthly.
The relationship test focuses on how both sides perceive their relationship. Factors include written contracts, employee benefits, duration of relationship and services provided. Does the worker have paid vacation and/or retirement benefits? Is the relationship long-standing?
You must look at the 20 factors and three-factor tests through the lens of the entirety of the relationship. Some of the tests may lean toward treating the worker as an employee, whereas others lean toward independent contractor. This is why determining the correct classification can sometimes be difficult.
In addition to the IRS, the DOL uses an economic reality test that focuses on six factors. The DOL test is more likely to classify a worker as an employee than the IRS.
Why is worker classification important? The consequences of a wrong classification can be severe, including criminal prosecution, and could be worse in the near future.
DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at www.about.dtnpf.com/tax. You may email Rod at firstname.lastname@example.org.
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