If you work for a living, do you know who your boss is? And if you run a business, do you know who’s on your payroll?
These are simple questions. But you may not have the same answers as the Internal Revenue Service.
The I.R.S. is emphasizing the distinction between employees and self-employed independent contractors this year, tax specialists warn. That makes it important for workers and critical for businesses that use their services to make sure to get the classification right. If you flub the answers, it could be costly.
In a sense, this is a semantic exercise: If someone is doing a certain kind of work for a specific amount of pay, the label you put on it might not seem to matter much. But which is which and who is who helps determine the obligations that each party in the relationship has to the other and to the I.R.S.
Contractors, being self-employed, are responsible for paying Social Security and Medicare taxes, and they are entitled to certain tax deductions for business expenses. If you’re an employee, though, you pay only half of these payroll taxes. Employers must cover the other half and now, if they’re big enough, health insurance under the Affordable Care Act.
“We are expecting that there will be greater scrutiny by the I.R.S. of the independent contractor/employee distinction,” said Jeffrey Saviano, Americas director of indirect tax at Ernst & Young. “The stakes are higher for companies and the government because of the implementation of the A.C.A. and the employer mandate taking effect in 2015.”
The law requires businesses with 50 or more full-time employees to provide them with health insurance that meets certain criteria deemed to make it affordable. Ian Shane, a tax lawyer at the New York firm Golenbock Eiseman Assor Bell & Peskoe, suggested that the desire to avoid the expense of providing coverage and the paperwork involved in demonstrating compliance provides an incentive for small businesses to find a way to classify some workers as contractors.
“If I have 60 employees, maybe I want 11 of them to be self-employed,” he said.
But wishing doesn’t make it so. If the I.R.S. decides that even one of those 11 is an employee, then the business must provide insurance.
The agency, which said in an emailed response to a question that it “regularly addresses worker classification issues as part of its employment tax examination program,” has a form, the SS-8, that workers and companies can use to try to place someone in the right category. Even with that, Mr. Shane said, it’s no easy feat.
“It’s a question of facts and circumstances and weighing all the things” together, he said. “No one or few things are definitive. In some respects it’s not that hard, and on another level it’s terribly hard.”
What it boils down to is that workers who decide how they perform their duties — executing them on their own schedule, at their own premises, with their own equipment and for clients of their own choosing – are more likely to be judged contractors. It also helps if the company that hires them treats other workers more like employees, offering steady work, paying benefits and providing work space, highlighting the contrast with how it treats people it considers contractors.
The I.R.S. is not the only regulatory authority that makes lists or needs to be satisfied. Jack Mozloom, a spokesman for the National Federation of Independent Business, pointed out that some states have their own criteria for classifying workers and that they are often at odds with or more stringent than the I.R.S.’s.
“It’s a state-by-state issue,” he said. “Some states have definitions of ‘independent contractor’ that are not consistent with federal law.”
“There’s a lot of paperwork” for prospective hirers, he said, “and no consistency.”
Connecticut, New Jersey and New York tend to have especially strict requirements, Mr. Mozloom said. They and others, like California, Illinois, Massachusetts, Oregon and Washington, can be difficult places to be self-employed, he said.
Workers are more likely to be deemed employees in such states. And a business that wants to use a contractor from one of them is more likely to be on the hook for payroll taxes and perhaps health coverage, he said, even if the business is elsewhere. After the job, the worker may file an unemployment claim, possibly meaning a higher unemployment tax rate for the business.
“If you’re a licensed contractor in one state, and a potential client in another state must consider you an employee, that can be a problem,” Mr. Mozloom said.
Gary Cuozzo, owner of the ISG Software Group in Wallingford, Conn., found state authorities so determined to reclassify his contractors as employees that he decided to outsource hiring to a third-party staffing agency, even though he estimates that it costs him 20 to 30 percent more than to engage a worker directly. That figure is rising, too, he said, because the agency he uses just raised its rates 2.5 percent to cover the expense of complying with the A.C.A. mandate.
“It’s getting harder to use somebody as a subcontractor,” Mr. Cuozzo said. “Everything has gotten so complicated that I only hire through an agency now. I got fed up dealing with it, and now with the Obamacare stuff, the whole thing has gotten grayer and more difficult.”
The employer mandate makes it more urgent to get the employee-contractor classification right, said Mr. Saviano of Ernst & Young, because a small mistake can have large repercussions. If a company has 49 full-time employees, the employer mandate doesn’t apply. With 50 or more, it applies to everyone. If the I.R.S. finds that enough workers at a company are employees, not contractors, he said, then stiff penalties apply, and they are based on the entire payroll, not just the number of misclassified employees.
The prospect of providing health coverage and other expensive benefits means that companies often prefer to consider workers contractors. For workers, those same factors often make it better to be classified as employees, but not necessarily. In general, someone with higher earnings and big potential tax write-offs — for example, a surgeon who attends many conferences in exotic locations — benefits from contractor status, Mr. Shane said.
If you would rather be considered a contractor by the I.R.S. when a company engages your services, a contract calling you that probably won’t help much, he added. But a clause entitling you to work for other businesses would be useful.
“You need more than one customer,” Mr. Shane said. “A true independent contractor has numerous clients and takes risks. The more risk you take, the more you’re self-employed.” In any case, he said, the I.R.S. is more inclined to penalize the business, not the worker, when the agency disputes a claim that a worker is independent.
That possibility, and the heightened jeopardy that businesses face as the employer mandate takes effect, means that companies must take pains to make sure that workers are given the right status, Mr. Saviano said, and they have to continually confirm that they made the right call and that the designation is still accurate.
“If there are material changes in worker responsibility and how the worker does his job, they need to be flagged,” he said. “Whenever it comes down to facts and circumstances, you need to have the right controls in place. These are difficult issues.”