Payroll Webinar: W-2’s vs. 1099’s: Understanding Who Should be an Independent Contractor

©2019 The Payroll Advisor
1
W-2s vs. 1099s—Who
Should be an
Independent Contractor
Presented onThursday, January 10, 2019

Housekeeping
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Today’s
topic

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Our Focus ForToday
 Worker Classifications
 What is the common law
rule and how to apply it
 TheThree Factors that
apply to worker status
 IRS v. FLSA on
independent contractors
and employees
 Don’t forget the states
have a say on who is an
employee
 Form SS-8
 Who gets a W-2 and who gets a
1099 and why the twain should
never meet
 What triggers a 1099 audit—its
easier than you think
 What are the penalties for
misclassifying workers
©2019 The Payroll Advisor 6

Under IRS Classifications

Common Law Employee
 Anyone who performs services for an
employer is an employee if the employer can
control what will be done and how it will be
done—a matter of control
 Makes no difference how it is labeled
 Full or part time doesn’t matter
 No distinction between classes of employees

Common Law Rule
 No exact statute stating who is an
employee
 Known as the common-law rule
 IRS calls it “The right to direct and
control”
 Treasury Regulations Section
31.3121 (d) – (1) (c), paragraphs (1)
and (2)
 If it walks like a duck…

Characteristics of Employees
 Employer provides instruction,
tools, supplies and training
 Employer can discharge
 Employee can quit
 Services are performed
personally
 Continuous relationship
 Employer hires and pays
assistants and staff

What is an Independent Contractor?
 Are self employed
 Employees of no other entity
 You have the right to control
or direct only the result of the
work and not the means
and/or methods of
accomplishing the result

Characteristics of an Independent
Contractor
 Sets own order and sequence of
work
 Works for more than one person
or firm
 Offers services to the general
public
 Contract agreements are in effect
 Furnishes own tools

Determining Who Is an Employee
 IRS regulations are not spelled out in terms of
one law.
 Tests of characteristics, job duties and intent
 Boils down to the matter of control
 20 facts are divided into three categories that
provide evidence of control

3 Categories of Evidence of Control
 Behavioral Control
 Financial Control
 Type of relationship

3 Categories

Behavioral Control
Facts that show whether the
business has the right to direct
and control how the worker does
the task for which the worker is
hired.

Behavioral Control
 Also includes type and
degree of:
 Instructions that the
business gives to the
worker
 Training given to the
worker

Instructions
 Where and when to do the
work
 What tools and equipment
to use
 Hiring of assistants
 Providing supplies
 Order and sequence of work

What If No Instruction?
 Amount needed varies for different
jobs
 Behavioral control may exist if
employer has right to control how
work results are achieved
 Business may lack knowledge in
highly specialized fields
 Task may require little or no
instruction

Key Consideration
The business has
retained the
right to control
the details of
the worker’s
performance

Training
Worker is trained to perform services in a particular
manner

Financial Control

Business Expenses
 Employees are
reimbursed for business
expenses
 Independent contractors
are not
 Not a hard rule…of
course!

Worker’s Investment
 Employees do not have an investment in the
facilities he or she uses
 Independent contractors usually do
 Again, not actually a requirement…but it
helps!

Availability of Services
 Independent
contractor’s
services are
available to the
public
 They advertise
 The big Kahuna!

Paying theWorker
 Employees are generally
guaranteed a regular wage
amount for an hour, week or
other period of time
 Independent contractor is
paid a flat fee for the job
 There are exceptions—i.e.
lawyers

Profit and Loss
 Employees are paid a wage
without deductions for costs of
doing business
 Independent contractors would
have expenses to offset any
profits.

Type of Relationship
 Written contracts
 Benefits
 Permanency of relationship
 Key aspect of the regular
business of the company

Written Contracts
 Describes the
relationship the parties
intended to create
 NO! Having a written
contract does not make
a worker an independent
contractor

Benefits
 Does the company provide
the worker with employee
type benefits such as
insurance, a pension plan,
vacation or sick pay?
 Yes – Employee
 No- Not necessarily an
independent contractor

Permanency of Relationship
 Is the worker engaged with the
expectation that the relationship
will continue indefinitely rather
than for a specific project or
period?
 Evidence the intent was to create
an employer-employee
relationship

Key Aspects of Business
If the worker provides services that
are a key aspect of the regular
business activity it is likely you
have the right to direct and control
his or her activities
Which means that they are an
employee

Pit Falls
 Consultants
 Especially former employees
or retired employees
 Employees performing other tasks
 Watch out for the states
 Especially for SUI – May not
match IRS
 May use ABC test

Safe Harbors
 Section 530
 Reasonable basis
test
 Must complete all
federal returns and
provide Form 1099-
MISC
 5 tests

FiveTests for Safe Harbor

 Provided by IRS to help determine status
 They will review and give ruling-not the first
choice by most
 Easy to complete yourself--then apply the
results—a little safer in most cases
 There are state equivalents
 Let’s do a quick review of the form’s
questions-see where they are looking

This is the identification info on the
employer and the worker in question…

39
Part I: General Information on the
worker and the employer: total of 11
questions to answer
Here are questions 1-6:

40
Part I: General Information on the
worker and the employer: total of 11
questions to answer
Here are questions 7-11

41
Remember they are looking for your
control of this worker

42
Looking for the control of the
money on this part

Control in the relationship is their
search in this part

For those who have sales or service workers

EmployeeVs. Independent Contractor:
Reporting Requirements
Employee:
Form W-2
Independent Contractor:
Form 1099-MISC if qualifies
with $600 or more for year
One worker should not get both in the same year—can
trigger audit—unless of course they should… for example
hire an independent contractor as an employee mid-year.
Best time to
change over—
January 1

Isn’t JustTax Related
 Department of Labor has the
Employee Misclassification Initiative
 37 states have signed an MOU to work
with the DOL—Latest OK January, 2017
 In FY 2015, the DOL collected over $78
million in back wages for minimum
wage and overtime violations under
the FLSA stemming from employer’s
misclassification of employees as
independent contractors.

StatesWith No MOU Or It has Expired
 Delaware
 Indiana
 Kansas
 Michigan
 Ohio
 South Carolina
 Washington-expired
 Wisconsin-expired

MT
WY
ID
WA
OR
NV
UT
CA
AZ
ND
SD
NE
CO
NM
TX
OK
KS
AR
LA
MO
IA
MN
WI
IL IN
KY
TN
MS AL GA
FL
SC
NC
VA
WV
OH
MI
NY
PA
MD
DE
NJ
CT
RI
MA
ME
VT
NH
AK
HI
Status of MOUs or Partnerships and the
States
48
Expires in 2020
NO MOU has been signed as of yet
Expires in 2019
Expires in 2021
Expired in 2018
Expired in 2017

Employees UnderThe FLSA
The test for determining whether an employer-
employee relationship exists under the Fair Labor
Standards Act is broader than the IRS common law
test.

FLSA Has Recently Stated…
 The FLSA definition of employ, which
includes “to suffer or permit to work,” was
specifically designed to broadly cover as
many workers as possible.
 The economic reality of the worker’s
relationship with the employer determines
whether the worker is economically
dependent on the employer (and therefore,
an employee) or is in business for himself or
herself (and therefore, an independent
contractor).

Significant Factors For Economic
RealitiesTest
1. Is the work an integral part of the employer’s
business?
2. Does the worker’s managerial skill affect his
or her opportunity for profit and loss?
3. Relative investments of the worker and the
employer
4. The worker’s skill and initiative
5. The permanency of the worker’s relationship
with the employer
6. Employer control of employment relationship

RealitiesTest
1. Is the work an integral part of the employer’s
business?
For example, the work of a carpenter is integral to the
operation of a construction company but a worker
engaged by a construction company to repair a copier is
not
2. Does the worker’s managerial skill affect his
or her opportunity for profit and loss?
Ability to make independent business decisions, such as
deciding to make business investments or hire helpers.
But not deciding to work more jobs or longer hours

RealitiesTest
3. Relative investments of the worker and
the employer
The worker must make some investment but not
merely purchases tools to perform the job
4. The worker’s skill and initiative
The skills should demonstrate that the worker
exercises independent business judgment or
initiative. Specialized skills do not indicate
independent contractor status

RealitiesTest
5. The permanency of the worker’s relationship
with the employer
Permanent or indefinite suggests an employee but
absence does not automatically indicate independent
contractor. Is it the worker’s choice?
6. Employer control of employment
relationship
Independent contractor works relatively free of control.
Factors include hiring and firing; amount of pay; hours
worked and how the work is performed. Lack of control
does not automatically classify as independent
contractor. Must exercise control over meaningful
aspects of the work.

TheWHD Points OutThat…

How Do I Get Caught?
 Random audit by IRS-not
likely unless you had more
than one form for a worker—
but they are looking for it
 Audit due to other audits—
FLSA will get you IRS—State
will get you IRS
 They are teaming up on this
one—especially for SUI audits

Getting Caught
Employee:
 By accident—applied for unemployment
 On purpose-found out not eligible for SUI or
found out about double the FICA for self
employed

Penalties
If the IRS reclassifies an individual from independent
contractor to employee, the employer may be
required to pay penalties for the misclassification.
Under the IRS Code the penalties may be:
1.5% of the employee's federal income tax liability, AND
20% of the amount that should have been withheld for the
employee's FICA

Penalties…
 If the employer failed to file the information
returns (e.g., Form 1099) before the
reclassification, the penalties double to 3% and
40% respectively.
 Can get one time interest free adjustment on
Form 941 failures
 That’s just the IRS…there is a state involved
there somewhere
 Many states have passed specific laws for
misclassification of employees…

For Example--Missouri
Sec. 285.515
If a court determines that an employer has
knowingly misclassified a worker, the court
shall enter a judgment in favor of the state and
award penalties in the amount of fifty dollars
per day per misclassified worker up to a
maximum of fifty thousand dollars.The
attorney general may enter into a consent
judgment with any person alleged to have
violated sections 285.500 to 285.515.

States May Use a DifferentTest for SUI
 IRS and some states use independent
contractor factor test that we just discussed
 State may use another test—ABCTest
 IRS test less inclusive than ABC test—Looks
at only whether the employer has control
 Two different determinations can be made
using both tests
 Used mainly for SUI determinations
 CA using for wage orders eff. 4-30-18

MT
WY
ID
WA
OR
NV
UT
CA
AZ
ND
SD
NE
CO
NM
TX
OK
KS
AR
LA
MO
IA
MN
WI
IL IN
KY
TN
MS AL GA
FL
SC
NC
VA
WV
OH
MI
NY
PA
MD
DE
NJ
CT
RI
MA
ME
VT
NH
AK
HI
ABCTest or Common LawTest by State
62
ABC Test
Common Law Test
Own tests but based on control factors
and/or ABC test

ABCTest for SUI
The employer must be able to demonstrate
that all three parts of the "ABCTest" are met.
Those tests are:
A. Such individual has been and will continue
to be free from control or direction over the
performance of such services, both under his
contract of service and in fact; and

ABCTest for SUI
B. Such service is either outside the usual
course of the business for which such service is
performed or that such service is performed
outside of all the places of business of the
enterprise for which such service is performed;
and
C. Such individual is customarily engaged in an
independently established trade, occupation,
profession or business.

Time for Questions

66
How Ascentis
Payroll can help
Payroll
HR &
Benefits
Talent
Management
Recruiting &
Onboarding
Time &
Attendance
› Easy to use W2 preparation,
delivery and filing
› Report on 1099 individuals and
earning codes
› Ascentis provides paper and
paperless options

Learn more
Learn more about how Ascentis can help support your W2 and 1099 payroll needs

Contact Us
webinars@ascentis.com
www.ascentis.com
800.229.2713

Payroll Webinar: W-2’s vs. 1099’s: Understanding Who Should be an Independent Contractor

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