1099 Versus W-2 Classification
IRS worker classification remains a priority. The IRS continues to seek back payroll taxes and penalties from firms that wrongly treat workers as contractors. Unreported or underreported employment taxes make up a big chunk of the overall federal tax gap.
Worker Classification – Three Tests
IRS uses three tests to classify workers, with each of the tests made up of multiple factors.
The behavioral test looks at whether the firm controls or has the right to control the worker’s job. Key factors for employee status include instructions about doing the work, evaluation criteria and training.
The financial test looks at who controls the economics of the worker’s job. Being able to work for multiple firms and providing your own tools needed for the job are indicative of independent contractor status. Some factors favoring employee status are eligibility for reimbursement of travel costs and payment based on hours worked.
The type-of-relationship test examines how the parties perceive each other. Evidence of an employer-employee setup includes giving paid sick and vacation days and retirement benefits, as well as hiring the worker to render services indefinitely rather than for a specific time period or project. Written language in a contract stating the worker is an independent contractor isn’t determinative under this factor.
Section 530 Relief
Sometimes IRS is prohibited from reclassifying contractors as employees.
This happens when the firm qualifies for Section 530 relief, a provision in a 1978 law. The business must have at all times treated similarly situated workers as contractors and filed 1099s for the disputed workers. In addition, the company must have a reasonable basis for treating them as contractors and not employees.
IRS’s Voluntary Classification Settlement Program.
Firms that have consistently treated workers as contractors and given them 1099s for prior years. A firm needn’t have a reasonable basis for the misclassification. The firm must agree to treat the workers as employees in the future and issue W-2s.
Labor Department and Worker Classification
The Labor Department is also getting aggressive about worker classification.
It issued a tougher interpretation of the classification rules for workers under the Fair Labor Standards Act. The proposed regs would rescind previous rules published by Donald Trump’s administration in early January 2021. The new proposal, which focuses on the totality of the circumstances, has a non-exhaustive list of factors for a firm to consider in determining whether its workers are employees or contractors. The rule, if finalized as proposed, is expected to increase the number of workers that are classified as employees when compared with the 2021 regulations.
POL’s rules won’t change the federal tax standards for worker classification. The Revenue Service will continue to use the three-factor test described above. But POL, as is its practice, will share misclassification referrals with IRS.
If Labor tells the Service that a firm’s workers are employees for labor law purposes, the company will face an uphill battle convincing IRS otherwise for tax purposes.