Performing Services in Multiple Roles As Both Employee and Independent Contractor: Recent IRS Guidance
The Internal Revenue Service (“IRS”) recently issued an Information Letter providing that an individual can be both an employee and an independent contractor simultaneously, for the same company, when working as a professional consultant on two separate projects.[1] The Information Letter indicates that when an individual performs services in two separate roles for a single company, the relationship between that individual and the company is examined separately for each group of services being provided. Whether an individual is in an employee, independent contractor or simultaneous employee/independent contractor relationship has both tax and employee benefit repercussions.
Background. The IRS looks to all relevant facts and circumstances and to applicable provisions of the Internal Revenue Code (the “Code”) to determine whether an individual is an employee, subject to federal employment taxes, or an independent contractor. Code section 3121(d)(2) defines an employee as any individual who, under the common law rules applicable in determining an employer-employee relationship, has the status of an employee. In determining whether an individual is an employee under the common law rules, the IRS takes into account all of the facts and circumstances relevant to each particular case. Treasury Regulations provide that an employer-employee relationship exists when the person or business for whom the services are performed has the right to direct and control the individual who is performing the services, not only as to the end results of the work, but also as to the details and means by which the results are accomplished. (See Treas. Regs. section 31.3121(d)-1(c)(2); see also Treas. Regs. section 31.3401(c)-1.) The person or business for whom the services are performed does not actually have to direct or control the manner in which the services are performed; it is sufficient if such person or business has the right to do so.
In determining whether an individual is an employee or independent contractor under the common law rules, the IRS will consider all evidence of control or autonomy (any designation of the relationship by the parties is immaterial). In this regard, the IRS classifies the relevant facts as generally falling into three categories of evidence to be considered: (i) behavioral controls, (ii) financial controls, and (iii) the relationship of the parties. Behavioral controls are evidenced by facts that illustrate whether the company has a right to direct or control how the individual performs the specific tasks for which he or she is hired. Financial controls are evidenced by facts that illustrate whether the company has a right to direct or control the financial aspects of the individual’s activities, including the method of payment, the individual’s opportunity for profit or loss, and whether the individual has made a significant financial investment or has incurred unreimbursed expenses. The relationship of the parties is generally evidenced by the parties’ agreements and actions with respect to each other, including facts that show not only how they perceive the relationship but also how they present the relationship to others.
If an employer-employee relationship is found to exist, the employee’s income is generally subject to Federal Insurance Contributions Act (“FICA”) taxes and income tax withholding, and the employer has an obligation to withhold and report these taxes. (See Treas. Regs. section 31.3121(d)-1, relating to the Federal Insurance Contributions Act (“FICA”), and section 31.3401(c)-1, relating to federal income tax withholding.)
A company may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to request an IRS determination of the status of an individual providing services as an employee or an independent contractor.
Information Letter 2012-0069. The Information Letter specifically addresses the status of an individual who was providing services to a company as a professional consultant on two separate consulting projects. Based on the factors discussed above, the IRS found that, in certain situations, it is possible for an individual to be both an employee and independent contractor with respect to a single company. In this regard, in determining whether an individual is providing services in two separate roles for a company, the IRS examines separately the relationship between the individual and the company for each group of services being provided. If an employer-employee relationship is found with respect to only one of the roles performed by the individual, then only the remuneration from that role will be subject to FICA tax and income tax withholding. If an employer-employee relationship is found for both roles, then all remuneration received by the worker will be subject to FICA tax and income tax withholding.
Repercussions If Independent Contractor Status is Overturned. Employers who misclassify individuals as independent contractors can incur tax liability and face penalties for failing to pay employment taxes and failing to file required tax forms. (See Code section 3509.) Employers who misclassify individuals as independent contractors can also risk incurring substantial liability for employee benefits (including retroactive accrued benefits under defined contribution and defined benefit plans, stock and other property awards under incentive and deferred compensation plans, as well asother benefits) that should have been provided to the individual but were not, because of such misclassification.
What To Do Now. It is important that employers properly classify the individuals they hire to work for them as independent contractors or employees (or both, if performing separate projects in separate capacities). In general, if an employer has the right to control or direct not only what is to be done by an individual, but also how it is done, then the individual is more likely an employee. Conversely, if an employer can direct or control only the result of the work done by an individual (and not necessarily the means and methods by which the individual accomplishes the result), then the individual is more likely an independent contractor.
Employers should examine any contracts or agreements they currently have with individuals classified as independent contractors. A statement in an agreement that labels an individual as an independent contractor is not sufficient to determine the individual’s status for IRS and employee benefit purposes. The business relationship between the individual and the business should be examined based on all relevant facts and circumstances. In this regard, all documentary and operational information that provides evidence of the degree of control and independence should be considered, including any facts that provide evidence of behavioral control, financial control and the type of relationship, as discussed above. If the individual’s classification is still uncertain, the employer should consider filing with the IRS a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
In the event that, upon later review, an employer needs to reclassify an individual as an employee, the employer may be eligible to apply for relief under the IRS Voluntary Classification Settlement Program (“VCSP”). (Please see our prior alert on the VCSP, “New Settlement Program for Misclassified Workers Provides Employers with a Unique Opportunity.) In a news release issued on February 27th, the IRS announced that it would be expanding several eligibility requirements of the VCSP, making it possible for many more employers, particularly larger ones, and even employers under audit (except for an employment tax audit) to apply for the program. (See IR-2013-23.) In addition, employers accepted into the program will no longer be subject to a special six-year statute of limitations, but rather the three year period that normally applies to payroll taxes. Interested employers can apply by filing Form 8952, Application for Voluntary Classification Settlement Program, with the IRS. Until June 30th of this year, employers who would normally be ineligible to apply for the VCSP, because they failed to file Forms 1099 for the past three years with respect to individuals sought to be reclassified, are eligible to apply.
Finally, employers should review their employee benefit plans and programs to ensure that (i) relevant provisions expressly guard against potential liability for benefit accruals and awards in the event of worker reclassification, and (ii) the classes of individuals who are eligible and ineligible to participate are clearly defined in the applicable benefit plans and programs.
[1] Information Letter 2012-0069, issued by the Division Counsel/Associate Chief Counsel of the Tax Exempt & Government Entities Division of the IRS. This Information Letter is intended to provide only general principles of the law; it is intended for informational purposes only and does not constitute a ruling.
