November 18, 2014

What you need to know about plan audits: Employee vs. independent contractor audits, Part I

This is Part I of the fourth and final installment in a series of posts explaining the different types of audits that may impact your employees, your benefit programs, and your business, and how you can be prepared if you are audited.

Now that we have reviewed health and welfare plan audits, retirement plan audits, and HIPAA privacy audits, let us turn our attention to employee versus independent contractor audits.

Eeny, meeny, miny, moe... employee or independent contractor: Do you know?

This question is an important one to the government and to the employer, as well as to the individual. It is not a decision that can be made using a childhood rhyme. It is, in fact, a facts and circumstances determination. Very bluntly, this status is an important financial determination.

In a nutshell, there are three primary tests that are used by the Internal Revenue Service (IRS) to differentiate between employee and independent contractor status. They are:

  1. Behavioral control: Does the employer direct and control how the work is done? 
  2. Type of relationship: How do the parties perceive the relationship?
  3. Financial control: Does the employer direct and control the financial and business aspects of the job?

If the employer has the right to control or direct what is to be done, as well as how it is to be done, then an employer/employee relationship likely exists. This issue was born out of a recent case in the U. S. Court of Appeals for the Ninth Circuit relating to an employer’s misclassification of common law employee versus independent contractor. Both cases center around FedEx classifying certain drivers as independent contractors rather than employees, and thus, “forcing them to incur business expenses and depriving them of benefits otherwise owed to employees” under both California and Oregon laws. In both cases, the FedEx drivers were required to drive FedEx-approved vehicles, wear FedEx uniforms and adhere to FedEx grooming standards, as well as follow other FedEx policies and procedures. FedEx advised the drivers on which packages were to be delivered by date and time, and only on FedEx-approved routes. In its findings, the Ninth Circuit panel determined that the “right to control” is the primary test for determining employees versus independent contractors.

If the employer has the right to direct and control the result and not the methods and means of accomplishing the work, then an independent contractor relationship likely exists.

Many different jurisdictions and agencies have an interest in proper classification of individuals including, but not limited to, the IRS for tax collection purposes, the Department of Labor (DOL) for minimum wage and overtime reasons, various state agencies that regulate unemployment, workers compensation, labor and revenue. Each of these entities has its own definitions of “employee” and “independent contractor” that must be considered. Many of these agencies are working together in their audit programs. For example, the IRS and Department of Labor entered into a memorandum of understanding a few years ago, together with several state agencies, to share information relating to employee status, all of this in an effort to ensure that individuals are properly classified.

An employer’s workforce audit can be triggered by any one of the agencies listed above. Triggers might include: worker complaints; review of tax filings, including Forms W-2 and 1099, and other reporting forms; individuals filing for unemployment benefits or filing workers’ compensation claims or disability claims; or individuals filing a Form SS-8 to determine their own status as employee or independent contractor.

Be sure to check out Part II of this post as we continue to discuss considerations when classifying employees.


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