In today’s business environment, more and more companies are using the services of independent contractors. It is important to know how the IRS classifies workers for the determination of independent contractor status and to know some history if you weren’t a business owner during the early 1990s.
Back in the early 1990s the Internal Revenue Service (IRS) used a very strict set of guidelines to determine if a worker should be classified as an independent contractor or employee. Often called the 20 rule checklist, if a worker didn’t meet the criteria of all 20 items on the IRS audit list the IRS reclassified them as employees and held the employer responsible for all payroll taxes that would have been withheld as an employee. So many small businesses were closed down by the IRS under the strict rule that congress passed an amendment to the tax code called The Small Business Job Protection Act of 1996.
The Small Business Job Protection Act essentially took the enforcement teeth out of the current tax code regarding the issue of independent contractors vs. employees and the IRS all but stopped doing reclassifications of workers. In October 1996 the IRS released a manual for its auditors to use to determine classification of independent contractors. That manual is still in use today and sets the standards for employers to use when determining employee or contractor status.
Many employers are still under the belief that the 20 rule test still exists and that the IRS is rigidly enforcing the standards but that really isn’t the case.
The IRS now states on its web pages addressing the issue:
“People such as lawyers, contractors, subcontractors and auctioneers who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees. However, whether such people are employees or independent contractors depends on the facts in each case.
The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.”
The standard for making the determination of contractor or employee status no longer requires a rigorous 20 point standard and instead focuses on examining the means and methods a worker uses to accomplish a task to determine status. The new test is more of a common sense and common law test.
From the IRS website:
“Common Law Rules
Facts that provide evidence of the degree of control and independence fall into three categories:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?” Tax regulations require any independent contractor paid more $600.00 during the calendar year to be issued an IRS form 1099-MISC by January 31 and must have 1099 records submitted to the IRS by February 15.
If you have any questions about classification of workers you should discuss the matter with your CPA for clarification.