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The “New” IRS Independent Contractor Test – The More Things Change the More They Stay the Same

OVERVIEW Proper characterization of workers as independent contractors or employees is a question that crosses many areas of substantive state and federal law, prominently federal tax law. IRS Publication 15-A, Employer’s Supplemental Tax Guide (2020) (Dec 23, 2019), https://www.irs.gov/pub/irs-pdf/p15a.pdf (“Pub. […]


OVERVIEW

Proper characterization of workers as independent contractors or employees is a question that crosses many areas of substantive state and federal law, prominently federal tax law.

IRS Publication 15-A, Employer’s Supplemental Tax Guide (2020) (Dec 23, 2019), https://www.irs.gov/pub/irs-pdf/p15a.pdf (“Pub. 15-A”) announces relevant new or changed standards to be used by the Internal Revenue Service in making these determinations for tax year 2020. Pub. 15-A announces a policy of the IRS to focus on three “areas” of criteria in applying the preexisting “control test.” Significantly, the fundamental “control test” and its prior explication set out by the Service in the so-called “20 Factor” test remain valid.

Pub. 15-A also announced a new reporting form for mandatory employer use in reporting of workers determined to be independent contractors.

For completeness, I note that Pub. 15-A also discusses the threshold determination of “Who Are Employees?” and outlines the four types of business relations between the employer and persons performing services, which are:

  • Independent contractor;
  • Common-law employee;
  • Statutory employee; or,
  • Statutory non-employee.

See, Pub. 15-A pages 5-7, including examples of each.

Additional resources and comments are included in the last section below.

1. CONTROL TEST, REDUX

It is of course an understatement to say that there are multiple tests and lists of criteria for characterization of a worker as an employee or independent contractor, developed under the Internal Revenue Code for revenue purposes, under other federal laws for other regulatory purposes, and under state law for purposes arising otherwise. (The scope of Michigan or other state law is beyond this Note).

The thrust of Pub. 15-A appears to bring some additional order or guidance to preexisting criteria, and not to change those criteria or tests.

Under Pub. 15-A, the overarching issue in determining whether a worker is an employee or independent contractor remains the level of authority the employer retains to direct and control the worker’s activities. “In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.” Pub. 15-A p. 7 “Common-Law Rules” section. See generally, Pub. 15-A pp. 7-10.

The 20-Factor Test Remains Valid. The longstanding “20 factor” test to distinguish an independent contractor from an employee, set forth in Rev. Rul. 87-41, remains valid.

“Grouping” of Factors. Effective January 1, 2020, the IRS will “group” factors and focus on three areas of the control test:

  • Behavior Control;
  • Financial Control; and,
  • The type of relationship of the parties.

Pub. 15-A provides:

Behavior Control. Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:”

  • Exercise of direction over time and place and sequence or means of work;
  • Whose instrumentalities (tools or equipment) are used;
  • Engagement of other workers;
  • Whether specific duties are assigned to a specific worker;
  • Instructions that the business gives to the worker;
  • Training that the business gives to the worker.

Financial control. Facts that show whether the business has a right to control the business aspects of the worker’s job include:”

  • Who pays unreimbursed business expenses;
  • The extent of the worker’s investment in facilities or tools used;
  • The extent to which the worker makes the services available to the relevant market;
  • How the business pays the worker (salary or wage vs. fee-based);
  • The extent to which the worker realizes profit or loss.

Type of relationship. Facts that show the parties’ type of relationship include:”

  • Existence and terms of a written contract;
  • Provision of benefits to worker;
  • Permanency of relationship;
  • Whether the services involved are a regular business activity of the employer.

2. NEW REPORTING REQUIREMENT

The 1099-MISC form previously used for reporting of independent contractor compensation has been a confusing “collection bin” for various characterization and reporting issues beyond that status. For tax year 2020, Employers are required to use a new reporting form, 1099-NEC Nonemployee Compensation, replacing the prior 1099-MISC to report compensation payments to persons the employer elects to characterize as independent contractors. See, About Form 1099 NEC, Nonemployee Compensation, https://www.irs.gov/forms-pubs/about-form-1099-nec, and form 1099-NEC, available at https://www.irs.gov/pub/irs-pdf/f1099nec.pdf.

3. FURTHER CONSIDERATIONS

Workers Misclassified? What to Do? The IRS Voluntary Classification Settlement Program provides guidelines to be followed by employers wishing to reclassify workers for future tax periods. See, Pub. 15-A p. 7 and Voluntary Classification Settlement Program. https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program.

Relief from Liability for Mischaracterization. Unchanged by Pub. 15-A, the IRS provides potential “safe harbor” relief from liability arising from mis-characterization and mis-reporting under Section 530 of the Revenue Act of 1978, P.L. 95-600. The reporting business must meet all of the following:

  • Reporting consistency;
  • Substantive (fact) consistency; and,
  • Reasonable basis for the characterization.

See, Publication 1976, Do You Qualify for Relief Under Section 530? At https://www.irs.gov/pub/irs-pdf/p1976.pdf.

Department of Labor Test For FLSA. The Fair Labor Standards Act (FLSA) overtime and minimum wage requirements do not apply to independent contractors. The DOL website comments that a worker may be properly characterized as an independent contractor under other statutory schemes, but not for FLSA enforcement purposes. See, Get the Facts on Misclassification Under the Fair Labor Standards Act, https://www.dol.gov/whd/workers/Misclassification/misclassification-facts.pdf. The DOL notes that proper classification depends on the totality of the circumstances of the activity or situation, not a specific rule or test. See, DOL Fact Sheet 13, Employment Relationship Under the Fair Labor Standards Act (July 2008), https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship.

If you have any questions on these changes, please contact Dave Houston at 517.377.0855 or dhouston@fraserlawfirm.com.


Fraser Trebilcock Shareholder Dave Houston has nearly 40 years of experience representing employers in planning, counseling, and litigating virtually all employment claims and disputes including labor relations (NLRB and MERC), wage and overtime, and employment discrimination, and negotiation of union contracts. He has authored numerous publications regarding employment issues. You can reach him at 517.377.0855 or dhouston@fraserlawfirm.com.