There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: The past decade or so has seen the rise of the gig economy from Fiverr to Uber, and even small businesses that need occasional seasonal or flexible labor are in on the gig economy. And [00:00:30] so over the years, it's become more and more difficult for both workers and employers to know when to classify a worker as an independent contractor versus an employee. And the rules can be difficult to understand because this is one of the areas where we have not only multiple different definitions of employee at the federal level, but we also have states that have their own definitions [00:01:00] and even debates that are going on within those states over who is an employee versus who is an independent contractor. So, for example, California, over the last decade or so, has had some significant legal debates and even discussions that went as far as changing state law. And then, uh, long court cases that seem to drag on over certain, uh, types of professions and industries that rely [00:01:30] on gig labor and whether those workers should be employees or independent contractors. And the tax consequences can be significant for both the employer and the worker. So it's really important to understand from both perspectives what a worker actually should be classified as. While this creates opportunities for workers to earn in [00:02:00] the gig economy. It also leaves them ineligible for employment benefits. Fair labor protection and payroll tax matching. And this is really the most important aspect of this discussion from a tax perspective.
Jeremy Wells: Again, there are multiple definitions within federal law which I'll talk about in a moment. But we're going to focus mostly in this episode. And then in the next episode, this is going to be a two part series on worker classification [00:02:30] and misclassification, and especially focusing on the payroll tax part of this discussion. Again, there are, uh, legal debates, there are legislative debates, and there are even courtroom debates over how these workers should be classified depending on what industry they're in, depending on the kind of work they do. But ultimately, what it comes down to from a tax Hack's perspective is who's responsible for the [00:03:00] payroll tax or self-employment tax? That's the result of the, uh, money earned as a result of doing that work. So in this episode, I'm going to break down worker classification from a federal tax law perspective, looking at how the IRS and the courts distinguish between employees and independent contractors and discussing relief available to misclassified workers. [00:03:30] In part two. So part one is going to focus on how we distinguish in terms of federal tax law between employees and independent contractors. In part two, we're going to come back and look at what happens when we have a misclassification, what workers can do about that misclassification, and also what employers can do about that misclassification. So for now, for this episode, we're going to look at identifying the common law definition of [00:04:00] employee.
Jeremy Wells: And this is what we use for federal tax law purposes. We use the common law definition or it's also known as the common law standard. We're going to apply that common law standard that control standard, uh, as a legal test. And we're going to look at the three categories of evidence of control and how those apply to worker classification. We're going to look at [00:04:30] the evolution of that control standard and how we arrived at the three categories of evidence briefly. And then in the second episode, we're going to come back and think about how are we going to advise a misclassified worker or the employer of a misclassified worker. So let's jump into this. How do we classify workers for federal tax law purposes. Now I'm going to preface this discussion and I've already said this a [00:05:00] couple times, but I just want to make sure this is clear that employee that term means different things in different contexts. The legal meaning of employee is contextual, meaning it differs across different parts of the law. As I've said, there are multiple definitions just within federal law. There are also definitions that depend on the state you're in. And because of the way the US [00:05:30] government system works, there can be conflicts between those definitions. We're going to look at some examples of where those definitions and the differences in those definitions can have a meaningful impact on the worker and on the employer.
Jeremy Wells: So for example, though, employee can have a different definition when we're talking about labor protections, such as [00:06:00] minimum wages and overtime than it does when we're discussing employee benefits such as retirement contributions. Those are different parts of federal law. Also, federal tax law is going to have a different definition than those other two. And when you look at how the definition of employee can matter to a worker and to that worker's employer, it can matter a great deal depending on which context [00:06:30] we're discussing the issue in. So if you're looking at court cases where the definition of employee was central to that case, it depends on whether that case was about worker protections, such as overtime or minimum wage, versus whether it was about retirement contributions under R.eza or whether it's about payroll tax issues under tax law. And those different court cases will draw on different [00:07:00] parts of federal law. They will also draw on different precedents within the court cases and opinions that have evolved over time. For that particular meaning of employee, like I said, this discussion is going to focus on the meaning of employee the way it's used in title 26 of the US code. Now that is of course, the Internal Revenue Code. That's federal tax law. So we're [00:07:30] specifically looking at the meaning of employee for employment tax purposes in subtitle C of title 26. Subtitle C is the part of the Internal Revenue Code that focuses on employment taxes.
Jeremy Wells: So that's going to be FICA or Social Security and Medicare. It's going to be Futa unemployment tax. And then it's also going to be federal income tax withholding. Those three parts of what [00:08:00] an employer needs to be aware of when it comes to classifying. Worker as an employee and paying that employee wages and making sure that the employer was withholding correctly, withholding Fico, Social Security and Medicare, paying into federal unemployment, and then also withholding federal income tax from that employee. Uh, those three aspects of employment taxes are central to [00:08:30] this discussion of the definition of employee and also employment for federal tax purposes. So as an example of how this distinction, among the different meanings of employee in federal law can be important, uh, even for tax professionals to be aware of these multiple different meanings. Let's look for a second at labor law versus tax law, and how those can [00:09:00] have two different meanings of employee and how that could actually matter for tax professionals. So the US Department of Labor ensures employees covered by the Fair Labor Standards Act, the FLSA receive minimum wage and overtime protections. Now the FLSA is incorporated into the US code under title 29. Title 29 [00:09:30] is about labor law. Federal labor law. Title 29 is a separate title from US code. It's a whole separate part of federal tax law from a whole separate part of federal law, from federal tax law, which is title 26, the Internal Revenue Code.
Jeremy Wells: So there are separate contexts, separate parts of the federal law. They have different meanings of that word employee. So the protections guaranteed by the [00:10:00] FLSA are not available generally to independent contractors. The Department of Labor uses the economic reality test to determine if a worker is an employee. This is what the Department of Labor has come up with in terms of its internal guidance on how to classify a worker as either an independent contractor or an employee for [00:10:30] the purposes of the Fair Labor Standards Act, FLSA. That economic reality test includes looking at the opportunity for profit or loss depending on managerial skill. Investments by the worker and the employer. Permanence of the work relationship, nature and degree of control that the employer has over the worker. Whether the work performed is integral to the employer's business. And then the skill and [00:11:00] initiative required of the worker. Now those are the different criteria that are part of the economic reality test that the Department of Labor uses to determine whether a worker should be classified as an employee or not. For purposes of protections under the FLSA, overtime, minimum wage, things like that. Now, that is going to be different from the way tax [00:11:30] law is going to discuss the differences between employees and independent contractors. Now, from the Department of Labor's internal guidance, what the Department of Labor calls fact sheet 13 employee or independent contractor classification under the FLSA.
Jeremy Wells: The Department of Labor says this whether a worker is an employee or an independent contractor under the FLSA is determined by looking at the economic realities of [00:12:00] the worker's relationship with the employer. If the economic realities show that the worker is economically dependent on the employer for work, then the worker is an employee. That term economically dependent is critical. It's it's one of the most important parts of this entire definition way of thinking about the difference between an employee versus an independent contractor. For labor law standards here, if the economic reality [00:12:30] show that the worker is in business for themselves, then the worker is an independent contractor. The economic realities of the entire working relationship are looked at to decide whether a worker is an employee or an independent contractor. Employment under the FLSA is not determined by technical concepts or common law standards of control. It is broader than the common law standard often applied to determine employment status under other [00:13:00] federal laws. This part right here referencing that common law standard of control. That is what we're going to talk about here in a minute as the tax law definition of employee versus independent contractor. So Department of Labor is basically saying that the definition and the distinction between employee and independent contractor for labor law reasons is actually broader in scope and includes [00:13:30] more criteria than the tax law definition does.
Jeremy Wells: Now, why would I bring this up and spend a relatively decent amount of time on this when we're discussing the tax law approach to employee versus independent contractor and worker classification, because now as tax professionals, we actually need to be thinking about what is the definition of an employee, not just for tax law purposes, but also for [00:14:00] federal labor law purposes, because we have a new deduction. That was part of the one big, beautiful bill act passed in the summer of 2025 that specifically references the Federal Labor Standards Act, FLSA and the Fair Labor Standards Act, FLSA, saying that an employee who is covered under [00:14:30] FLSA, section seven, which deals with employees who are required to be paid overtime for the work they do if that worker is required to be paid overtime under FLSA section seven. Then that worker may qualify for a deduction for from part of the overtime payment that that worker earned. So now as tax [00:15:00] professionals, we not only have to understand the worker classification for tax law purposes, but we also need to understand what the labor law definition of an employee is, at least in terms of understanding whether or not a worker qualifies for that overtime deduction. It's important to understand that a worker can be considered an employee under FLSA [00:15:30] and therefore eligible for potentially deductible overtime, yet not considered an employee for federal employment tax purposes. Now of course this is going to be rare, but it is actually possible.
Jeremy Wells: And in fact, when you look at the guidance that IRS issued in late 2025 and notice 20 2569, there is a discussion of how employers should report overtime paid to [00:16:00] workers who are covered under FLSA, section seven, but are not employees. For payroll tax purposes and so won't receive a W-2. Again, this is going to be rare, but because we have different definitions of the same word in different titles of the code, then we have the potential for an individual employee to be A, for an individual worker to be an [00:16:30] employee under one title and not another. There is a precedent in. Common law and federal common law that says that a word, a term, a term of trade has to have the same meaning within a title of the US code. So if we look at the usage of a word, a key term like employee across the US code, when we go [00:17:00] from one title to another title, it can have a different meaning in different titles. It should have the same meaning within a title. So employee should have the same meaning throughout title 26 or the Internal Revenue Code, but it can have a different meaning and a different title like title 29, which is labor law. So it's important to keep this in mind, especially now that Congress has decided to draw on a meaning of employee, at least for purposes [00:17:30] of the overtime deduction from a different title than title 26.
Jeremy Wells: Okay, let's move on and talk about what we actually mean by employee for federal tax law purposes. Now within title 26 we actually have a statutory definition of employee. This is in IRC section 3121 D. We have four different definitions [00:18:00] of the term employee here. The first one is a common law employee. And we'll talk about what that means. Because this is really the main part of this discussion. What do we mean under common law. By the term employee. And then there are some specific groups that are called out as employees by definition. The first one is an officer of a corporation. And there are some caveats to that. But in general, any officer of a corporation [00:18:30] is by definition, statutorily an employee. We'll talk about that a little bit more later on, too. There's also the so-called statutory employee. There are a few groups of professions of workers who will automatically qualify as employees for certain reporting purposes, and not for others, statutory employees. It's kind of a weird group. I'll break that down a little bit here in a minute. And then the fourth group is defined as an individual who [00:19:00] performs services that are included under an agreement entered into pursuant to sections 218 or 218 cap A of the Social Security Act. Now, this is a particularly, uh, specific definition here. Basically, what this is, is accounting for the fact that the Social Security Administration has agreements with certain state, local and tribal governments to extend Social [00:19:30] Security coverage to specific positions, not individuals, but positions within those governments, and it effectively treats them similarly to private sector employees in terms of benefits and taxes, payroll taxes, rather than treating them as government employees.
Jeremy Wells: Generally, that's going to be predefined by those existing intergovernmental agreements, not something we as tax professionals would have to worry about. However, those other three [00:20:00] groups common law employee, an officer of a corporation, and then statutory employees. These three are generally where we're. We might as tax professionals, especially if we're advising an employer, are going to need to advise that employer specifically on some worker classification issues. So let's look at the common law meaning of employee. This is probably the most important part of this discussion to fully understand. [00:20:30] And there's actually a lot here. I'm going to focus really on the on the critical aspects of this discussion. There is, uh, about a half a century worth of, of court cases that have contributed to this meaning of the term employee. Some of those are from the tax court. Some of those are from the federal court system, meaning district courts, appellate courts, some of them [00:21:00] even rising up to the Supreme Court. I'm going to summarize a lot of this, uh, because there's frankly just too much in the way of covering all of the common law development of these, uh, the meaning of employee when it comes to federal tax law.
Jeremy Wells: Essentially, what has happened in terms of defining the term employee for [00:21:30] federal tax law purposes, though, is, the coalescence of all of these different court opinions and arguments around the. This common law meaning of employee. And essentially it hinges on a few characteristics of the relationship between the employer and the worker. The most important part of this relationship characteristic of the relationship is the right to control [00:22:00] the details and the means of work. That is going to be the control standard that the Department of Labor was referencing in its fact sheet 13. When talking about other federal definitions of employment and employee. Is that right to control? We'll break that down a little bit more here in a minute. But essentially, think of this as the what and how of that relationship. So the right to control the details [00:22:30] and the means of work is essentially the right to control what the worker is working on, how the worker is working on that, and what the worker is going to use to perform that work. So what tools, what software, what specific locations, uh, then how they're going to do that, what steps they're going to use, what procedures they're going to follow. We'll break all this down here in a minute. Another, [00:23:00] uh, characteristic of the relationship here is furnishing tools and a place to work.
Jeremy Wells: So the where and the when of the relationship, typically an employer is going to require its employees to use certain tools, certain software, certain processes and procedures, and even require that worker to work in a specific place at a specific time. So you're looking at having a [00:23:30] centralized place of work, an office or a manufacturing facility, and then you're going to have set hours of work that are determined by the employer. Now, obviously, in the modern economy, we have a lot of distinctions that can be present in this particular part of the relationship. So we might have work from home where we no longer have a centralized office location. We also might have workers who work on their own schedules. [00:24:00] So it's not so much about what part of the day they're working, but that they're working a specified number of hours throughout the week or month or whatever the reporting period is. So there can be a lot of flexibility there. This takes us back to that previous characteristic, the right to control the details and the means of work. We're going to talk about this distinction here. When we talk about that control standard, that it's less about whether the employer actually does [00:24:30] control the worker, and more about whether the employer retains the right to control the worker. That's going to be a critical distinction that's going to pop up. And then finally, there is this characteristic of the right to discharge.
Jeremy Wells: In other words, the right to decide who is doing the work. So an employer has the right to hire and fire workers. Now there might be some limitations on those rights, either due to employment [00:25:00] law or due to the contract between the employer and the worker. But essentially, the employer has the right to hire and fire whomever it wants, and therefore that's part of that common law meaning of employee. Now, an independent contractor is typically subject to control only as to the desired result, not the means or the methods of doing the work. So from this common [00:25:30] law control standard, in essence, what we're looking at is whether the employer controls the, uh, how the worker is producing the result, or if the employer is just determining the desired result. And then the worker is free to use whatever tools, methods, processes, procedures, time, [00:26:00] location in order to produce that desired result. What we really have in the final analysis, and I'll talk about this a little bit later on, but what we really have in the real world is a spectrum. And on one end of that spectrum is a pure independent contractor where the employer just says, this is what we want you to do. Now go do it. On the other end of that spectrum, we would have an employee where [00:26:30] the employer tells the employee exactly how to do every single step, when to do it, where to do it.
Jeremy Wells: Really, what we have for most workers in the economy is somewhere in between. Some mix of the two. Most workers are going to find themselves on this spectrum somewhere between those two ends, either a pure independent contractor or a pure employee. What we as tax professionals might have to do when we're advising employers [00:27:00] and maybe even workers who potentially are misclassified by their employers, what we might have to do is make a determination of which end of that spectrum does this worker lean toward more? This all comes from Treasury Regulation section 31.31 21 D1C2. So there's a lot here in this particular regulation that breaks down [00:27:30] that particular meaning of employee. And you'll notice that that regulation citation is very similar to the tax code citation I gave, uh, from the previous section here. It's, it's basically, uh, Treasury breaking down Congress's definition of an employee statutory definition of an employee in IRC section 3121 D and then Treasury is taking that and making an entire regulation based off of that. Uh, [00:28:00] one more point here when it comes to the common law, meaning of employee is when we look at individuals who are providing professional services to the public. Those individuals specifically are called out in the regulation as generally not employees. Now, there is a caveat here. You can be a professional working in a firm and be an employee of the of that firm or of the owners of that firm.
Jeremy Wells: Generally, though, [00:28:30] professionals offering their services to the public, such as accountants, attorneys, architects, engineers, right. These individuals typically are going to be independent contractors, or at least if they're working as individuals. Now, if they're working collectively in firms, then you might have employees of that firm. Again, this is all coming from that same regulation. Now within the common [00:29:00] law definition of employee. Here we have this control standard or the control test. Now common law results from the precedent established by the courts. That's what we mean by common law. Common law is essentially the accumulation of recurring precedents, uh, opinions where courts seem to keep coalescing around the same opinion on a similar question. And that's exactly what we have here with the common law definition [00:29:30] of employee. Multiple courts throughout the federal court system have essentially coalesced around. This definition of employee for purposes of federal tax law, that an employee or a worker is an employee. If the employer passes essentially this control standard, right. Over time, various tests of employer control developed throughout the federal court system, and eventually the IRS and the Social [00:30:00] Security Administration compiled a list of 20 factors used by the courts to determine worker status. And the IRS published this as revenue ruling 8741. You can go look up that revenue ruling. You can read through a discussion of all 20 factors that the IRS and Social Security Administration came up with together.
Jeremy Wells: What's clear about this 20 factor test, though, is that it was provided as an analytical tool for [00:30:30] IRS staff as well as tax professionals and employers. It's not a legal test for determining worker status. The legal test is whether there is a right to direct and control the means and details of the work. That is the control standard. That is what common law tells us the definition of an employee is. So what we're trying to do is come up with an analytical framework, trying to come up with a way of essentially simplifying the [00:31:00] determination of whether this worker is under the right to direct and control the means and details of the work by the employer. There are some important court cases in this now. This is by no means an exhaustive list. There are there are at least a couple hundred of these cases that come up. If you just do a search, there are at least a couple dozen that are precedential that are important in [00:31:30] this conversation. But I'm going to go over, uh, just, uh, or I'm just going to provide a few of these here so that after you finish listening to this episode, if you want to look into this issue more and how this definition has evolved over time, you can look at them. One of the most important here is Weber V Commissioner. This is 103 uh tax court opinion. 378.
Jeremy Wells: This came from 1994. This was also a firmed by the Fourth Circuit the following [00:32:00] year 1995. Another critical one is professional and Executive Leasing incorporated V Commissioner uh, that came out of the ninth Circuit in 1988. And then Simpson v commissioner was a tax court opinion in And 75. Those are just a couple of cases to see where the courts have kind of coalesced around this common law. Meaning of employee there by no means no means exhaustive, but they are [00:32:30] critical in this discussion. Now, in 1987, IRS published in that revenue ruling the 20 Factor test. In 1996, the IRS published a training manual for examiners, and in that training manual, the IRS reformulated its approach to the control test by focusing on just three categories of evidence and essentially [00:33:00] combining those 20 different factors into the three categories of evidence. They didn't they didn't exactly override or replace the 20 factor test. Essentially, what they did was basically just Group the most important and most relevant ones together into three categories of evidence. And it's important to understand that these are termed categories of evidence. They are not themselves legal [00:33:30] tests. Again the control standard is the legal test. They're also not factors because this is a reformulation, a grouping together of some of those factors into these three categories. The first one is behavioral control. The second one is financial control. And the third is relationship of the parties. So we essentially get some of those 20 different factors reorganized into [00:34:00] these three categories of evidence.
Jeremy Wells: And the way this training manual reads, it essentially walks the IRS examiner through each of these three categories of evidence and explains what the examiner should be looking for with regard to these three different categories. So for behavioral control we're looking at the details and means of performance. Behavioral control essentially means the right to direct or control [00:34:30] the details and means by which the worker performs the required services. So we're looking at things like instruction, how the job actually gets done, rather than just the end result, right? So if I hire a worker and I tell that worker, I need you to produce a widget for me, and I don't tell them anything more than that, then I have given that worker essentially no instruction. And at least in terms of this part of the definition of [00:35:00] that control standard, I haven't given that worker any instruction that would tend toward that worker being classified as an independent contractor. But if I told that worker, here's exactly how I want you to produce this widget. Or these are the steps to produce a widget. This is the time frame during which you should produce a widget. Here are. Here's the equipment that you can use to produce a widget. If I give them some instruction in how to do [00:35:30] it, then that's leaning more toward being an employee.
Jeremy Wells: Another important criterion here in the behavioral control category is identification as a worker associated with the employer. So we're looking at essentially uniforms and logos here. Wearing uniforms and displaying the company logo, for example on the side of the truck or van may indicate employment. [00:36:00] Those tend to be strong signs that the worker in that truck or the worker wearing that uniform is actually an employee. However, with the rise of delivery services, with the rise of at home services, there has been a concern about security of customers. So if I call a company and I have an issue with that company and they need to send a technician to my home, I [00:36:30] need some way of verifying whether the individual that shows up on my door was really sent by that company, or maybe this person is not actually working for that company. Is there to do something else? Right? Something that I don't want that individual to do. So customer security concerns have led some of these companies to insist that their workers dress up in their uniforms, have their logos displayed on their equipment, on their [00:37:00] vehicles, even though they're classified as independent contractors. And taking this into account, IRS is willing to, uh, acquiesce on the point that just because a worker wears the uniform, displays the logo, doesn't necessarily mean that worker must be classified as an employee. It's entirely possible that that worker is is properly classified as an independent contractor, but still wears the uniform displays logo.
Jeremy Wells: Another [00:37:30] critical part of behavioral control is evaluation. So one was instruction telling the worker how to do the work. The flip side of that is evaluation monitoring and reviewing the worker's performance. So evaluation of how work is performed can indicate greater control and therefore might lean more toward classifying that worker as an employee. Now the scope, degree, and [00:38:00] source of instruction and evaluation matters. So more detailed instructions or mandatory Suggestions can indicate greater control than less detailed instructions or optional suggestions, and then instructions imposed by the business merely to ensure compliance with customer orders or governmental or governing body regulations may [00:38:30] indicate weaker control than more stringent guidelines imposed directly by the business. So, for example, in the accounting profession, we have a lot of rules about how accounting works, how tax return preparation works. We have to make sure that all of our workers are at least minimally complying with legal requirements, professional best practices, uh, generally accepted accounting principles that are [00:39:00] required by professional associations. So there might be a lot of rules about how the work needs to get done. But we as the employer are not choosing to impose those directly on the worker. We just have to make sure that the work actually meets those standards because we're part of that profession. That's not up to us. So just because we are requiring our workers to follow industry best practices, for example, doesn't mean that [00:39:30] our workers are properly classified as employees.
Jeremy Wells: They might still be independent contractors. If we work in a profession that requires certain standards be met. Now, training can also fit into behavioral control here. If it is required, periodic or ongoing training on methods and procedures that can actually indicate a greater level of control. But if it's voluntary, and especially if it's uncompensated training, that might indicate [00:40:00] less control. Financial control is the second category of evidence here. Here we're looking at the economic aspects of the worker's activities. Some of this might sound similar to the Department of Labor's economic dependency tests. However, it's not the same thing. And so I'm going to walk through some of the, uh, ways of looking at evidence within this category [00:40:30] of financial control. And then we'll talk about how this is distinguished from the Department of Labor's definition of employee and labor laws, federal labor laws, definition of an employee. So here, financial control means the right to direct or control the economic and business aspects of the worker's activities. So what we're looking at here is who makes the significant investment of providing equipment and paying for large expenditures, all relative [00:41:00] to the work at hand. Now, in general, we're looking at this relative to the work being done and to the employer and the worker themselves. I run an accounting firm. The biggest expense in terms of equipment that we have is computers.
Jeremy Wells: That's nothing compared to buying large equipment for a factory or a big manufacturing facility, for example. So relative to other industries and professions, [00:41:30] we might not have to invest a lot of money into our workers and their ability to do their work. But relative to our profession, it might be a significant amount. So what we're looking at is relatively large expenditures or investments in equipment that are either paid by the employer or by the worker. If they are covered by the worker, that tends to indicate an independent contractor. However, [00:42:00] the lack of those relatively large expenditures doesn't really tell us much, because a contractor could rent equipment or the contractor could find cheaper alternatives that work just as well. And so there are multiple ways that a contractor might find a way around making those relatively large purchases. Another important piece of evidence here is business expenses. Who is incurring the costs and are reimbursements [00:42:30] being made. So choosing to incur unreimbursed expenses typically indicates that the worker has the right to direct and control the financial aspects of the business operations. In other words, that that worker is probably an independent contractor. But again, if you're working in a field that doesn't have a the need for reimbursement, that doesn't have a lot of cost being incurred while that worker is performing work, then it's entirely possible that a lack of evidence here [00:43:00] doesn't necessarily indicate one kind of worker classification over another.
Jeremy Wells: Another important part of this category here is market availability. So does the worker have the freedom to seek out new business opportunities while doing work for the employer? Independent contractors typically advertise and maintain a visible business presence, even while they have ongoing work with an employer. There are plenty of independent [00:43:30] contractors who have one, or maybe just a handful of relatively large clients, but it doesn't stop them from continuing to advertise and trying to find more work elsewhere. So it's possible that an independent contractor has a single client, is economically dependent on that client, but is still an independent contractor. So the question here, and this is the important distinction I was talking about, is whether the recipient, [00:44:00] the worker has the right to direct and control business related means and details of the worker's performance, not whether the worker is economically dependent on or independent of the business for which he or she performs services. So we're not looking at whether that one big client is going to make or break that worker. What we're looking at is whether that independent contractor has the right [00:44:30] to direct and control business related means and details of performance. This comes from a relatively important court decision here. Nationwide mutual insurance company V Darden in 1992. And this was a Supreme Court case in which the Supreme Court actually got in on this meaning of worker. Now, this particular case was an Orissa case.
Jeremy Wells: So it was about, uh, retirement contributions and not about federal [00:45:00] tax law? Not even about labor law, but rather about retirement. But it is still important to understand that when we're looking at different meanings of employee throughout federal law, that we're clear on what we mean by these different terms, such as control, right to control, and so on. Now, the method of determining payment can also help differentiate between employees and independent contractors. And this is another part of [00:45:30] the financial control category here. So salary or hourly wages typically indicate employment, although plenty of independent contractors, especially freelancers and firms as well, bill for time. So just having an hourly rate may not indicate that that independent contractor should be an employee. Instead, flat fees generally indicate pay for completed work and therefore an independent contractor, although not necessarily [00:46:00] there might be commission based pay, and that is one factor that could go either way. Independent contractors and employees both can, uh, make commissions. And then finally relationship. This is the intent concerning control here. We're looking at the contractual relationship, how the worker and the business perceive their relationship to each other and the party's intent, uh, concerning control. So [00:46:30] we're looking at a written agreement and that is going to help provide us with the facts and circumstances of the intent of both sides of this relationship in general, regardless of whether this worker is hired as an independent contractor, as an employee, it's always going to be nice to have something in writing, either an employment contract or some sort of agreement between the employer and the [00:47:00] independent contractor.
Jeremy Wells: That said, just because. What's in writing gives a label to the individuals involved or even to the relationship as a whole doesn't necessarily make it so. We still have to look at the substance of the relationship, not just what's in writing. So having that written agreement helps, but it doesn't necessarily dictate one way or the other. Incorporation [00:47:30] is also an important factor here. So if the worker registers a legitimate entity and the employer negotiates and contracts with that entity, and that entity is a legitimate actor in this relationship, and that entity follows corporate formalities and has at least one non-tax business purpose for existing, then that generally [00:48:00] helps support the recognition of that entity for federal tax purposes, meaning that the worker is working through that entity as an independent contractor of the employer. Now, that entity might be the worker's employer, but the worker is not directly an employee of the what at this point would be the client, right? The actual employer. And then we're also looking at the provision of employee benefits. Uh, this [00:48:30] provision indicates, uh, can indicate employee status. Now some benefits, uh, a tax qualified retirement plan, a 403 B annuity. A cafeteria plan can only be provided to employees by statute. So generally, if we see any of these kinds of benefits, then we by definition have an employee and not an independent contractor.
Jeremy Wells: However, I've got a three part series [00:49:00] of, of episodes that, uh, talk about the fringe benefits under section 132 of the IRC. Some of those benefits are available to independent contractors. There might be some accounting that needs to happen when those benefits are given to independent contractors as opposed to employees. However, when we're looking at these particular kinds of employee only benefits, retirement [00:49:30] plans, cafeteria plans, then we know we're dealing with a an employee in these situations, and we're really going to have to remind the employer of the importance of correctly classifying workers if they're trying to extend these benefits to a worker that is not currently treated as an employee. Now, when we look at weighing mixed evidence. So, for example, across these three different categories of evidence, a worker is rarely going to fit [00:50:00] squarely in one category or another. Like I said, most workers are going to exist on a spectrum here. So what we have to do is assess the relationship as a whole and determine whether evidence of control or autonomy predominates, and that the guidance given in that IRS examination manual now specifically called out a few groups. I want to quickly cover corporate officers [00:50:30] here. And in the next episode, we'll lead off with statutory employees and a few other groups that are specifically called out by statute.
Jeremy Wells: But I do want to cover corporate officers here. Corporate officers generally are considered employees, especially if they are providing services to the corporation. And this is critical if you are a tax professional working with self-employed [00:51:00] people who have an either a C corporation or especially an S corporation, or if you're a business owner and your business is taxed as an S corporation, a corporate officer of an S corporation that provides services to that corporation is an employee, meaning that individual needs to be paid wages. Those wages need to have Social Security and Medicare and federal income tax withheld from them. And that [00:51:30] employer needs to be paying Futa or unemployment tax. An officer who provides just minor or no services and is not entitled to receive directly or indirectly, any pay is not an employee. All of this comes from that same, uh, section of the Internal Revenue Code. 3120 1D1. And then also from that regulation. 31.31 21 [00:52:00] D1B the officer has to meet both of those requirements that that officer provides minor or no services and is not entitled to receive directly or indirectly, any pay in order to be accepted from employee status. In other words, what we're dealing with most of the time with S corporations is shareholders that are providing services. Unless there's some sort of silent partner or investor. [00:52:30] What we're dealing with is S Corporation shareholders who actually officer actually are officers of the corporation need to be paid through payroll.
Jeremy Wells: One of the ways that a lot of tax professionals like to try to use two wrongs to make a right by dealing with S corporations that failed to report wages paid to an S Corporation shareholder who's active in the business and is therefore a corporate officer, is [00:53:00] issue a 1099 neck from the S corporation to that individual? Like I said, that's that's two wrongs not making a right. Yes. That shareholder is now going to report some self-employment income and pay into Social Security and Medicare by virtue of self-employment tax. However, paying self-employment tax is different, even though they both go into Social Security and Medicare. That is different from paying FICA, [00:53:30] Social Security and Medicare. So it does not alleviate the corporation or the worker from the FICA, Social Security and Medicare tax liabilities that that worker might have. It's critical that we understand that an S Corporation shareholder officer is an employee for federal tax purposes. Never an independent contractor. A director of a corporation [00:54:00] in the capacity of being a director is never an employee of the corporation might be an independent contractor. So if you have a corporation with a board of directors, those directors are can be compensated for being a director of that corporation. That compensation is never wages. It will always be payments that are reported to independent contractors. However, [00:54:30] if the if that individual is also an officer of the corporation, then that individual will have a W-2, have wages paid from that corporation.
Jeremy Wells: If that officer is providing services to the corporation as an officer, it's entirely possible for a worker to earn compensation from the same employer as both an employer E and as an independent contractor, and [00:55:00] this is actually one of those cases. You can have an individual working as an officer for a corporation and as a director for a corporation. That individual's wages earned as an officer would be reported as wages on a form W-2, and then that individual's pay as a director of the corporation would be paid as, uh, as compensation to a Non-employee and therefore reported on A 1099 probably in AC. That's entirely possible. [00:55:30] Um, so you can have dual status workers for the same employer. I want to close this by saying that it's absolutely critical to understand this point that a corporate officer that provides services to the corporation is always an employee, and there is no way around that. Now I just want to close out this part one by going [00:56:00] back over those three categories of evidence behavioral control, which means the details and means of performance, financial control, the economic aspects of workers activities, and then the business relationship that intent concerning control. In part two, we will look at statutory employees, some other categories of employees, and look at what happens when an employer misclassifies a worker and [00:56:30] what kind of relief is available for the worker as well as the employer.