IRS Confirms Valid Use of Independent Contractors

An IRS official noted that it is a valid business position to classify workers as independent contractors, so long as the business follows the law in making the classification.  Anita Bartels, Program Manager for the IRS’s Employment Tax Compliance Policy section, speaking at the IRS’s Worker Classification webinar on February 15, 2012, reiterated that classification is usually based on the common-law test that examines whether the employer can control both the work that the worker performs and the method of doing the work.

Ms. Bartels mentioned that employers who want certainty with respect to whether an individual is an independent contractor or employee can file a Form SS-8 “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding” to obtain a determination from the IRS.  It takes about 6 months to receive a response to an SS-8 filing.  She also encouraged employers to consider the IRS’s Voluntary Classification Settlement Program (VCSP) announced in September.  Employers who enter VCSP agree to treat their workers as employees prospectively and settle past years’ liability for employment tax misclassification by making a minimal payment covering past payroll tax obligations.  Bartels stated that as of early January, the IRS had received 217 applications from employers wanting to reclassify workers as employees under VCSP, a number she said is generally in line with expectations.

Takeaway:

Although VCSP can be helpful with respect to federal taxes, there are many issues not covered by VCSP such as a company’s labor, unemployment, workers compensation, and employee benefit concerns, as well as state revenue and labor issues, that may be complicated by the company’s entry into the VCSP program, potentially leaving the business in jeopardy for misclassification liability regarding those matters.  Therefore, a thorough analysis should be undertaken and alternatives explored before enrolling in VCSP.

Pepper Hamilton’s multi-disciplinary Independent Contractor Compliance practice assists businesses in deciding if VCSP is a suitable course of action or whether they should consider alternative compliance solutions, including restructuring, re-documenting, reclassifying, or redistributing contingent workers.  Reclassification can also be accomplished under the VCSP or independently of the IRS program. Using IC Diagnostics™ and other proprietary tools, Pepper’s two dozen labor, tax, and employee benefit lawyers in its IC Compliance practice group are able to elevate the level of compliance of many companies and minimize or eliminate exposure to varied forms of misclassification liability.

Ms. Bartel’s comments reflect the understanding by the IRS and other federal and state regulatory agencies that many positions can be properly classified as either an employee or independent contractor provided that, if classified as the latter, the company does not have the right to control the manner and method of doing the work.  While this is a relatively simple test to articulate, the devil is in the details.  Indeed, the IRS’s fabled 20-factor analysis and court decisions determining independent contractor status examine a host of factors, reflecting that the common law test and many other independent contractor tests (such as the economic realities standard used by the U.S. Department of Labor and many states) are flexible and depend on the industry involved and the particular facts and circumstances of the positions in question.  Pepper Hamilton uses its proprietary 48 Factors-Plus™ analysis and IC Compliance Scale™ to assist companies in assessing and enhancing their independent contractor compliance.

Lisa Petkun
Richard Reibstein
Andrew Rudolph

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