Employee vs. Contractor: A Warning from the IRS About Getting it Right

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
jason@freemanlaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine , a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

The IRS recently issued a reminder, Notice FS-2017-09, to small businesses on the importance of properly classifying workers as employees or independent contractors.  Worker classification has long been a top enforcement priority for the IRS.  The notice warns that “[c]lassifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes.”  Improper worker classification can lead to a number of business risks.

The notice sets forth the IRS’s general, facts-and-circumstances position on the employee-independent contractor issue:

The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether a worker is an independent contractor or employee depends on the facts in each situation.

When it comes to worker classification, the IRS generally focuses on three categories of evidence: Behavioral Control, Financial Control and the Relationship of the Parties.  These categories generally encapsulate, and provide a framework for analyzing, the 20 common law factors designed to distinguish between employees and independent contractors.

Behavioral Control focuses on factors such as the type of instructions given to the worker, the degree of instruction (e.g., more detailed instructions may indicate that the worker is an employee); evaluation of systems to measure details of how work is performed; and training,

Financial Control focuses on whether the business has a right to direct or control the financial and business aspects of the worker’s job.  This category looks to factors such as whether the worker has a significant investment in the equipment he or she uses; whether the worker incurs unreimbursed expenses; whether the worker has an opportunity for profit or loss; and whether the worker makes his or her services available to the market.

The Relationship factor may look to factors such as whether there is a written contract describing the relationship that the parties intended to create; the benefits available to the worker; the permanency of the relationship; and whether the services are a key activity of the business.

Businesses that are uncertain about the proper classification of their workers should seek a legal opinion or should consider several legal options that may be available to minimize or completely eliminate exposure to taxes and tax-related penalties that may otherwise apply.  There are often legal strategies available to proactive businesses that may allow them to substantially reduce or, in some cases, eliminate their IRS risk for improper worker classifications.

For prior blog posts on employment tax and related worker-classification issues, see Employment Tax Enforcement is TrendingIRS Tax Penalties on the Rise, Particularly Employment Tax PenaltiesGovernment Report Recommends More Criminal Referrals for Employment Tax Violations.

 

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Freeman Law works with tax clients across all industries, including manufacturing, services, technology, oil and gas, financial services, and real estate. State and local tax laws and rules are complex and vary from state to state. As states confront budgetary deficits due to declining tax revenues and increased government spending, tax authorities aggressively enforce state tax laws to recapture lost revenues.

 

At Freeman Law, our experienced attorneys regularly guide our clients through complex state and local tax issues—issues that are frequently changing as states seek to keep pace with technology and the evolution of business. Staying ahead requires sophisticated legal counsel dedicated to understanding the complex state tax issues that confront businesses and individuals. Schedule a consultation or call (214) 984-3410 to discuss your Local & State tax concerns and questions?

 

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