Employees Vs Independent Contractors

<div class="Section1"><br /> <br /> An employer is entitled to deduct amounts paid as reasonable compensation to its employees.<a href="#_ftn1" name="_ftnref1">¹</a> Therefore, whether an individual is classified as an employee or as an independent contractor is important to an employer in determining whether or not that employer is entitled to deduct amounts paid to that individual as compensation.<br /> <br /> If an individual is properly classified as an independent contractor, the individual is entitled to deduct business-related expenses without regard to the 2 percent floor on miscellaneous itemized deductions (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8528">8528</a>) that would otherwise apply (note that all miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025). Conversely, the business expense deductions of an employee are limited based on whether or not the employee is reimbursed for the expense.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect; 162.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 62(c); Treas. Reg. &sect;&sect; 1.162-17(b)(2), 1.162-17(c).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> An individual whose net earnings from self-employment as an independent contractor equal $400 or more for the taxable year must pay the self-employment tax.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> In 2025, an individual who is liable for the self-employment tax must file a Schedule SE and pay Social Security taxes on up to $176,100 of self-employment income. The hospital insurance tax is imposed on all of a taxpayer&rsquo;s self-employment income.<br /> <br /> Despite this, an above-the-line deduction is permitted for one-half of the self-employment tax paid by an individual and attributable to a trade or business carried on by the individual as an independent contractor (not as an employee).<a href="#_ftn2" name="_ftnref2">²</a> If the individual also works in covered employment as an employee, his self-employment income (subject to the self-employment tax) is only the difference, if any, between his &ldquo;wages&rdquo; as an employee and the maximum Social Security earnings base.<br /> <br /> <em>See</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8570">8570</a> for a detailed discussion of the Social Security tax as it applies to self-employed individuals and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8572">8572</a> for a discussion of estimated tax payments.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect; 6017.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 164(f).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> While employers are often required to include all employees in fringe benefit plans and retirement plans, the same requirement does not apply with respect to independent contractors. If an employer includes non-employees (including independent contractors) in a qualified plan, that plan may lose its qualified status by violating the &ldquo;exclusive benefit&rdquo; rule of IRC Section 401(a). Therefore, most self-employed individuals who operate as independent contractors will be ineligible to participate in retirement savings plans maintained by another taxpayer-entity.<br /> <br /> For plan qualification purposes, a self-employed individual, as an owner-employee, is considered an &ldquo;employee&rdquo; for purposes of qualified plans established by that owner-employee.<a href="#_ftn1" name="_ftnref1">¹</a> An &ldquo;owner-employee&rdquo; is an employee who owns the entire interest in an unincorporated trade or business or, in the case of a partnership, owns more than 10 percent of either the capital interest or the profit interest in the partnership.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Even if a partnership agreement does not specify that a &ldquo;more than 10 percent interest in profits&rdquo; exists for any partner, if the formula for dividing profits (e.g., based on a partner&rsquo;s earnings productivity during the year) in operation produced a distribution at the end of the year of more than 10 percent of profits to a partner, the Tax Court has ruled that the partner is an owner-employee for the year.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> An individual who owns the entire interest in an unincorporated trade or business is treated as the employer.<a href="#_ftn4" name="_ftnref4">⁴</a> Thus, a proprietor or sole practitioner who has earned income (including &ldquo;self-employment income&rdquo;) can establish a qualified plan under which the individual is both employer and employee.<br /> <br /> A partnership is treated as the employer of each partner who is an employee.<a href="#_ftn5" name="_ftnref5">⁵</a> Thus, partners individually cannot establish a qualified plan for a firm, but the partnership can establish a plan in which the partners can participate.<br /> <br /> Individuals who are classified as independent contractors (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8723">8723</a>) are able to set up their own retirement plans, including IRAs and Roth IRAs, so long as they have compensation (whether in the form of self-employment income, alimony (prior to 2019) or income earned as an employee in some capacity) and, prior to 2020, did not attain age 70&frac12; during the year in which the account is established (the SECURE Act removed the age restriction for tax years beginning in 2020 and thereafter).<a href="#_ftn6" name="_ftnref6">⁶</a> To establish a Roth IRA, the same income limitations apply to self-employed taxpayers as apply to employees, so that the self-employed taxpayer must not have adjusted gross income in excess of the annual income thresholds. For 2025, those thresholds are: (a) $246,000 or above in the case of a taxpayer filing a joint return; (b) $165,000 or above in the case of a taxpayer filing a single or head-of-household return; or (c) $10,000 or above in the case of a married individual filing separately.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect; 401(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 401(c)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Hill, Farrer &amp; Burrill v. Commissioner, 67 TC 411 (1976), aff&rsquo;d, 594 F.2d 1282 (9th Cir. 1979).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect; 401(c)(4).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect; 401(c)(4).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; IRC &sect;&sect; 219, 408A.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; Notice 2024-40.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Although it has not been incorporated into the Internal Revenue Code, Section 530 of the Revenue Act of 1978 provides a limited safe harbor for employers to prevent the IRS from retroactively reclassifying certain independent contractors as employees.<a href="#_ftn1" name="_ftnref1">¹</a> The purpose of the safe harbor rule is to prevent reclassification in situations where an employer has a reasonable basis for classifying an individual as an independent contractor.<br /> <br /> An employer must satisfy three tests in order to qualify for relief under the Section 530 safe harbor:<br /> <p style="padding-left: 40px;">(1)&nbsp; The employer must have a reasonable basis for treating the individual as an independent contractor (the &ldquo;reasonable basis&rdquo; requirement (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8731">8731</a>));</p><br /> <p style="padding-left: 40px;">(2)&nbsp; The employer must consistently treat all similarly-situated workers as independent contractors (the &ldquo;substantive consistency&rdquo; requirement); and</p><br /> <p style="padding-left: 40px;">(3)&nbsp; All tax returns must have been filed on a basis consistent with independent contractor classification (the &ldquo;reporting consistency&rdquo; requirement).<a href="#_ftn2" name="_ftnref2">²</a> The Tax Court has found that the untimely filing of a taxpayer&rsquo;s Forms 1099 would <em>not</em> preclude relief under Section 530.<a href="#_ftn3" name="_ftnref3">³</a></p><br /> Whether the requirements of Section 530 have been satisfied is a question of fact to be decided by the courts. The employer has the burden of proof in showing that it is entitled to relief pursuant to the safe harbor provision.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Section 530 of the Revenue Act of 1978, P.L. 95-600 (as made permanent by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; <em><em>See, e.g.</em></em>, <em>303 West 42nd St. Enterprises, Inc. v. IRS</em>, 181 F.3d 272 (2d Cir. 1999).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; <em>Medical Emergency Care Associates v. Commissioner</em>, 120 TC 436 (2003).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> The amount of the deduction for a life insurance agent&rsquo;s expenses is directly related to the agent&rsquo;s status either as an independent contractor or an employee. Typically, whether an insurance agent is considered an independent contractor or an employee is determined on the basis of all the facts and circumstances involved. The IRS uses the same 20 factors discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8723">8723</a> in determining an individual&rsquo;s status as employee or self-employed person.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Under the common law rules, most life insurance agents are self-employed individuals, and this is their status generally for tax purposes. Thus, in the usual case, a life insurance agent reports income as an independent contractor, using Schedule C of Form 1040 for business income and deductions. This means that he may deduct <em>most</em> of his business expenses directly from gross income.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> However, even a life insurance agent who is an <em>employee</em> under the common law rules may be permitted to deduct certain business expenses directly from gross income. This rule is limited to those expenses for which reimbursement has been included in the agent&rsquo;s gross income. Work expenses which are not fully reimbursed are generally deductible as miscellaneous itemized deductions; thus, they are permitted only to the extent that the aggregate exceeds 2 percent of adjusted gross income.<a href="#_ftn3" name="_ftnref3">³</a> (Note that these deductions are not available for 2018-2025.)<br /> <br /> The IRS has ruled that a full-time life insurance salesperson is not an &ldquo;employee&rdquo; for purposes of IRC Sections 62 and 67, even though he is treated as a &ldquo;statutory employee&rdquo; for Social Security tax purposes.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> On the other hand, the IRS has found that a district manager of an insurance company was an employee of the company, and not an independent contractor.<a href="#_ftn5" name="_ftnref5">⁵</a> The IRS found that regional and senior sales vice presidents of an insurance company (but who were not officers of the company) were independent contractors and not employees of the insurance company.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> The courts have also made decisions in various cases concerning an insurance agent&rsquo;s classification as an employee or independent contractor. As with other employment situations, where an employer has the right to control the manner and the means by which the agent performs services, an employer-employee relationship will generally be found.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> However, according to decisions from the Sixth and Eleventh Circuits, the fact that an insurance agent received certain employee benefits did not preclude his being considered an independent contractor, based on all the other facts and circumstances of the case. The Sixth Circuit rejected the IRS claim that a discharge provision in an agreement between agent and insurance company guaranteeing that the agent would not be fired for unsatisfactory performance unless he was first given notice that his work was unsatisfactory and his job in jeopardy, and was given the chance to bring his performance up to satisfactory levels, provided the company with the &ldquo;right to control&rdquo; the manner in which the agent performed his work. The court ruled that the provision simply reflected both the importance the company attached to sales productivity and its willingness to provide low -producing agents with a chance to bring productivity to acceptable levels before being terminated.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> The Sixth Circuit Court of Appeals recently confirmed that&nbsp;lifeinsurance&nbsp;agents were properly classified as independent contractors, rather than employees. The case involved eligibility for benefits under ERISA, and a district court, using the traditional&nbsp;<em>Darden</em>&nbsp;factors for determining classification status,&nbsp;had ruled in 2017 that the agents were employees who were eligible for ERISA benefits. In reversing the lower court, the Sixth Circuit gave weight to the fact that both parties had expressed their intent that an independent contractor relationship would apply. The case also opens the possibility that the weight given to the various&nbsp;<em>Darden&nbsp;</em>factors should vary based upon the context of the case--for example, in this case, financial benefits were at issue, so the court gave more weight to the financial structure of the relationship.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Certain types of full-time insurance salesmen may qualify as &ldquo;statutory employees&rdquo; under IRC Section 3121(d)(3), rather than &ldquo;common law employees,&rdquo; and, as such, may use Schedule C of Form 1040 to determine net profit or loss.<a href="#_ftn10" name="_ftnref10">¹⁰</a> To qualify as a statutory employee under Section 3121(d)(3), the taxpayer must show: (1) that his entire or principal business activity was devoted to the solicitation of life insurance or annuity contracts; (2) that he did not have a substantial investment in the facilities used in connection with the performance of his services; and (3) that he is not a common law employee.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> <hr><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Rev. Rul. 87-41, 1987-1 CB 296.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 62(a)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&sect; 62, 67.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Rev. Rul. 90-93, 1990-2 CB 33.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; TAM 9342001.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; TAM 9736002.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; <em><em>See</em> Butts v. Commissioner,</em> TC Memo 1993-478; Let. Rul. 9306029.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp; <em>Butts v. Commissioner,</em> above. See also <em>Ware v. United States</em>, 67 F.3d 574 (6th Cir. 1995).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp; Jammal v. American Family Life Ins. Co., 2019 U.S. App. LEXIS 2905 (6th Cir. 2019).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp; Rev. Rul. 90-93, 1990-2 CB 33.<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp; <em>In the Matter of Appeal of M &amp; L Tofig</em>, No. 91R-0742-JV (California Board of Equalization Oct. 28, 1993).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Generally, a bona fide, arm’s length sale of a right to receive renewal commissions can successfully transfer the federal income tax liability on an insurance agent’s renewal commissions to the purchaser. If an agent sells the right to renewal commissions, the agent must report the entire sale price as ordinary income in the year the sale is made.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Renewals cannot be converted to capital gain by sale to a third party.<a href="#_ftn2" name="_ftnref2">²</a> In addition, the Tax Court has held that amounts received by a district manager upon the termination of his agency contract are treated as ordinary income and not capital gain resulting from the sale of a capital asset, if the money received was compensation for the termination of the right to receive future income in the form of commissions.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Apparently, the buyer must amortize his cost. In other words, the buyer can exclude from gross income in any year only that portion of the purchase price which the renewals received in that year bear to the total amount of anticipated renewals. The issue of whether the amount of deductible amortization is correctly determined requires consideration only of the contracts under which the buyer purchased the right to be general agent or purchased rights to renewal commissions.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  See <em>Cotlov v. Commissioner</em>, 228 F.2d 186 (2d Cir. 1955); <em>Turner v. Commissioner,</em> 38 TC 304 (1962).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  <em>Remington v. Commissioner</em>, 9 TC 99 (1947); <em>Davidson v. Commissioner</em>, 43 BTA 576 (1941).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  <em>Clark v. Commissioner</em>, TC Memo 1994-278.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  <em>Latendresse v. Commissioner</em>, 243 F.2d 577 (7th Cir. 1957).<br /> <br /> </div>

<div class="Section1"><br /> <br /> A general partner is treated as self-employed and income received from the partnership is, accordingly, treated as self-employment income.<a href="#_ftn1" name="_ftnref1">1</a> Income received by a <em>limited</em> partner, on the other hand, is generally not treated as self-employment income <em>unless</em> that income represents a guaranteed payment to the limited partner within the meaning of IRC Section 707(c).<a href="#_ftn2" name="_ftnref2">²</a> A payment will be considered &ldquo;guaranteed&rdquo; under Section 707(c) if it is made without regard to the income of the partnership.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If an LLC is taxed as a partnership, its members are treated as partners for tax purposes (including determining whether their income represents self-employment income).<a href="#_ftn4" name="_ftnref4">⁴</a> Despite this, in the case of an LLC member, if a member who has contributed both services and capital to the organization receives a distribution, the distribution should represent self-employment income insofar as it relates to the <em>services</em> contributed by the member. The difficulty arises in determining whether a distribution relates to the services or a return of capital.<br /> <br /> The Tax Court recently held that payments received by a taxpayer through his LLC were guaranteed payments, rather than partnership distributions, that gave rise to ordinary income tax liability because the payments were made without regard to the partnership&rsquo;s income and were made in exchange for the taxpayer&rsquo;s services, not as a return of partnership capital.<br /> <br /> In this case, after the taxpayer&rsquo;s employer refused to treat him as an independent contractor, the taxpayer resigned and formed an LLC through which he could perform the same services as a subcontractor for his former employer. The taxpayer received all payments for these services through the conduit LLC, which was taxed as a partnership, and labeled them as partnership distributions&mdash;arguing that the payments were made in exchange for the use of capital.<br /> <br /> The IRS disagreed with this characterization and instead reasoned that these payments represented guaranteed payments for services under IRC Section 707(c) and, therefore, generated ordinary income tax liability. The Tax Court agreed with the IRS, finding that the taxpayer here performed all services on behalf of the LLC, employed no employees and could not present any evidence that the payments, which were determined without regard to the partnership&rsquo;s income, were made in exchange for the use of partnership capital. As a result, the taxpayer was required to include the payments in calculating his ordinary income tax liability.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> While the IRS proposed regulations on the issue (<em><em>see</em></em> below), in 1997 Congress provided that the regulations would not be made final and the IRS has not proposed further regulations.<a href="#_ftn6" name="_ftnref6">⁶</a> Because of this, it is uncertain whether a distribution to an LLC member will be subject to the self-employment tax (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) in a situation where the distribution cannot be apportioned to show whether it relates to the member&rsquo;s services or capital contribution. Even in such a situation, the members of an LLC may still qualify as owner-employees for purposes of retirement plan qualification under the rules discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Proposed Treasury Regulation Section 1.1402(a)-2 was originally issued by the IRS in 1997. However, because of controversy over the self-employment tax treatment of limited partners who are active in a partnership&rsquo;s business, Congress prohibited the IRS from making the regulations final before July 1, 1998, believing instead that Congress should formulate such rules. Since the expiration of the moratorium, neither Congress nor the IRS has acted to clarify the self-employment tax treatment of LLC members, leaving the proposed regulations as the only administrative guidance on the matter. Thus, while the proposed regulations are not precedential, they can be relied upon to avoid a penalty under IRC section 6406(f). There is also judicial precedent, in <em>Elkins</em>,<a href="#_ftn7" name="_ftnref7">⁷</a> to reasonably conclude that the courts will sustain the position of a taxpayer who relies on proposed regulations.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect; 1402(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect; 1402(a)(13).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect; 707(c).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Let. Rul. 9432018.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; <em>Seismic Support Services v. Commissioner,</em> TC Memo 2014-78.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; TRA 97, &sect; 935.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; 81 TC 669 (1983).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> <em>Editor’s Note:</em> January 9, 2024, the Department of Labor (DOL) announced that it had finalized a standard for determining whether a worker is an employee or an independent contractor under the Fair Labor Standards Act.  The focus in determining independent contractor status under this rule hinges on the economic realities of the work relationship, including investment, opportunity for profit or risk of loss and whether the work is integral to the employer’s business.<br /> <br /> Under the rule, a six-factor "economic reality" test will consider: (1) the workers' opportunity for profit or loss depending on managerial skill, (2) investments by the worker and the employer, (3) the permanence of the work relationship, (4) the nature and degree of control exercised by the employer, (5) whether the work performed is integral to the employer’s business, and (6) the worker's skill and initiative.  Additional factors may be considered as relevant to determining whether the worker is economically dependent on the employer or in business for themselves.  States that use the so-called "ABC" test will not be impacted by the new rule, which is only used for FLSA purposes. The rule rescinded the 2021 standard discussed below entirely. In June of 2023, the National Labor Relations Board (NLRB) issued a ruling that follows this totality of the circumstances analysis.<br /> <br /> On May 6, 2021, the DOL announced its intent to withdraw the Trump-era rule designed to make it easier for employers to classify workers as independent contractors, rather than traditional employees.  The Trump-era rule focused on whether workers are economically dependent upon an employer—or in business for themselves. The now-withdrawn rule prioritized two key factors, including (1) the worker’s degree of control over the work performed, and (2) the worker’s opportunity for profit or loss. The DOL’s 2021 announcement stated that prioritizing these factors in determining employment status under the Fair Labor Standards Act (FLSA) would have undermined the longstanding balancing approach of the economic realities test and court decisions requiring a review of the totality of the circumstances related to the employment relationship. The Trump DOL rule would have resulted in many workers’ losing FLSA protections, including minimum wage and overtime benefits. Shortly thereafter, a group of businesses filed a lawsuit in federal court. The Texas Court agreed with the business groups and reinstated the Trump-era test, with an effective date of March 8, 2021. The court found that the DOL’s delay of the effective date for the Trump-era rule violated the Administrative Procedure Act by providing only a 19-day period for notice and comments (rather than the 30-day minimum). The court also found that the DOL limited the content of the responses to whether the effective date should be delayed (so unduly limited the scope of the comments received, making the decision to rescind the Trump-era rule “arbitrary and capricious”).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Generally speaking, an individual will be considered an employee under the common law rules if the person or organization for which the individual performs services has the right to control and direct the individual’s work, not only as to the result to be accomplished, but also as to the details and means by which that result is accomplished.<a href="#_ftn2" name="_ftnref2">²</a> In other words, an individual will be classified as an employee if the employer has the right to control not only what will be done, but also how that work will be accomplished. On the other hand, if the individual performing the work is only under the control of another to the extent of the end result that must be delivered, that individual will be classified as an independent contractor.<br /> <br /> It is important to note that the employer does not actually have to direct and control the manner of an individual’s work in order for that individual to be classified as an employee. The individual will be classified as an employee if an employer has the right to direct and control the manner in which that employee’s work is accomplished even if the employer does not actually exercise this right.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The parties’ classification of the relationship as anything other than an employer-employee relationship is immaterial if the facts and circumstances show that the individual is performing services as an employee.<a href="#_ftn4" name="_ftnref4">⁴</a> The IRS has developed three categories of control: behavioral control, financial control, and the type of relationship that exists between the parties.<a href="#_ftn5" name="_ftnref5">⁵</a> Additionally, the IRS has developed a 20 factor test that is often applied in determining whether an individual is performing services as an employee or an independent contractor. These 20 factors include the following:<br /> <p style="padding-left: 40px;">(1)  Instructions. If the individual is required to comply with another person’s instructions about when, where and how he or she works, that individual is usually an employee.</p><br /> <p style="padding-left: 40px;">(2)  Training. If an individual is trained alongside a more experienced employee or is required to attend training meetings, this indicates that the person for whom services are performed wants the individual to perform those services in a certain manner, making it more likely that an employer-employee relationship exists.</p><br /> <p style="padding-left: 40px;">(3)  Integration. When the success or failure of the business is significantly dependent upon the performance of services by the individual, the individual performing those services must necessarily be subject to a certain degree of control by the business owner, indicating that an employer-employee relationship exists.<a href="#_ftn6" name="_ftnref6">⁶</a></p><br /> <p style="padding-left: 40px;">(4)  Services Rendered Personally. If the services must be rendered personally, it is presumed that the person for whom the services are performed is interested in the methods used to accomplish the work, as well as the end results.</p><br /> <p style="padding-left: 40px;">(5)  Hiring, Supervising and Paying Assistants. If the person for whom the services are performed hires, supervises, and pays assistants, it can generally be shown that he or she exercises control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status exists.</p><br /> <p style="padding-left: 40px;">(6)  Continuing Relationship. A continuing relationship between the individual performing the services and the person for whom they are performed indicates an employer-employee relationship.</p><br /> <p style="padding-left: 40px;">(7)  Set Hours of Work. If the person for whom services are performed sets the individual’s hours of work, this factor indicates an employer-employee relationship.</p><br /> <p style="padding-left: 40px;">(8)  Full-Time Schedule Required. If the individual must dedicate substantially all of the individual’s time to the work, the person for whom the services are performed has control over the amount of time the worker spends working and impliedly restricts the individual from taking other work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.</p><br /> <p style="padding-left: 40px;">(9)  Work on the Employer’s Premises. If work is performed on an employer’s premises, control is suggested, especially if the work could be done elsewhere. Work done off premises indicates freedom from control, but is not sufficient, on its own, to show that the individual is not an employee.</p><br /> <p style="padding-left: 40px;">(10)  Order or Sequence Set. If the individual must complete the work in a certain order, this factor shows that it is likely that another is controlling his or her pattern of work.</p><br /> <p style="padding-left: 40px;">(11)  Oral or Written Reports. If oral or written reports must be submitted by the individual completing the work, it is likely that another is controlling his or her work.</p><br /> <p style="padding-left: 40px;">(12)  Payment by Hour, Week or Month. Payment by the hour, week, or month usually indicates an employer-employee relationship, provided that the payment method is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.</p><br /> <p style="padding-left: 40px;">(13)  Payment of Business or Traveling Expenses. If another pays the individual’s business or traveling expenses, an employer-employee relationship is indicated because the employer, in order to control the individual’s expenses, generally must have the right to direct the individual’s business activities.</p><br /> <p style="padding-left: 40px;">(14)  Furnishing Tools and Materials. If the person for whom services are performed furnishes significant tools and materials, this tends to show an employer-employee relationship.</p><br /> <p style="padding-left: 40px;">(15)  Significant Investment. If the individual invests in facilities that are usually used by workers in performing services, but are not typically maintained by employees (such as office space), this factor indicates that the individual is an independent contractor. Special scrutiny is applied in the case of home offices.</p><br /> <p style="padding-left: 40px;">(16)  Realization of Profit and Loss. An individual who can realize profit or loss as a result of the services offered is generally an independent contractor. The IRS uses the example of an individual who has a risk of loss with respect to liability for expenses, such as payment to unrelated employees (indicating independent contractor status), and distinguishes this type of risk from the risk that the individual will not receive payment for services (which is common to both employees and independent contractors).</p><br /> <p style="padding-left: 40px;">(17)  Working for more than One Firm at a Time. If an individual performs more than de minimis services for more than one firm at a time, this factor indicates that the individual is an independent contractor.</p><br /> <p style="padding-left: 40px;">(18)  Making Services Available to General Public. If an individual makes services available to the general public on a regular and consistent basis, this factor indicates that the individual is an independent contractor.</p><br /> <p style="padding-left: 40px;">(19)  Right to Discharge. The right to discharge an individual suggests an employer-employee relationship is present. An independent contractor, on the other hand, cannot be fired so long as the individual produces the end result that meets the contract specifications.</p><br /> <p style="padding-left: 40px;">(20)  Right to Terminate. If the individual has the right to terminate the relationship without incurring liability, this indicates an employer-employee relationship is present.<a href="#_ftn7" name="_ftnref7">⁷</a></p><br /> <br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> The California Supreme Court has abandoned the traditional multi-faceted test that has typically been used to determine employment status. Instead, the court determined that a three-factor “ABC” test is the correct standard to be employed under California state law. For a worker to be treated as an independent contractor in California, the following three prongs must be satisfied: (a) the worker has freedom from control over how to perform the service, (b) the service is outside the business’ normal variety or workplace and (c) the worker is engaged in an independently established role.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> In 2019, the DOL released an advisory opinion confirming that certain “gig” workers who are connected to consumers (i.e., those who need services) via a virtual marketplace community (VMC) are not employees of the VMC. The VMC at issue here did not provide any training to the workers, nor did it provide equipment, supplies or a workspace, although the VMC did provide information on interacting with consumers, best practices and basic information about the consumer’s needs. The VMC also did not monitor or supervise the worker’s performance, and did not require the worker to accept a certain number of jobs, although the VMC did impose a fee for late or cancelled work. The DOL applied the generally applicable principles in determining worker classification and found that the VMC was essentially a referral service and that they received no services from the worker. Further, the DOL rejected the idea that the workers should be employees because they were “integral” to the VMC’s business.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> <hr /><br /> <br /> All of the facts and circumstances of the relationship must be considered in weighing these factors to determine whether the relationship is an employer-employee relationship or an independent contractor relationship.No one factor will be determinative in making the correct classification.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Coalition for Workforce Innovation v. Walsh, Civil Action No. 1:21-CV-130 (E.D. Tex. Mar. 14, 2022).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 31.3121(d)-1(c)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 31.3121(d)-1(c)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Rev. Rul. 87-41, 1987-23 IRB 7.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  IRS Pub 15-A, Employer’s Supplemental Tax Guide (2019).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.  <em>See, e.g.</em>, United States v. Silk, 331 U.S. 704 (1947).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.  Rev. Rul. 87-41, 1987-23 IRB 7.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.  Dynamex Operations West, Inc. v. Superior Court, Super. Ct. No. BC332016, 4 Cal. 5th 903, 416 P.3d 1, 232 Cal. Rptr. 3d 1 (2018).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.  FLSA 2019-6.<br /> <br /> </div>

<div class="Section1"><br /> <br /> In some instances, a plan established by an owner-employee (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8726">8726</a>) will be entitled to ERISA protections (such as rules regarding the vesting of benefits and ERISA&rsquo;s anti-alienation provisions), but in other cases, participants in such a plan will not be entitled to the same protections as are available to traditional employees. The answer turns on whether employees other than the self-employed individual and the individual&rsquo;s spouse also participate in the plan.<br /> <br /> Regulations promulgated by the Department of Labor provide that an owner-employee and spouse are not considered employees of a business that is wholly owned by those individuals.<a href="#_ftn1" name="_ftnref1">¹</a> Therefore, if only the owner-employee and spouse participate, the plan will not be subject to ERISA. Accordingly, Section 514(a) of Title I of ERISA would not preempt state regulation of the arrangement.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> However, the Supreme Court has ruled that if the owner-employee and spouse allow additional employees to participate in the plan, that plan will be subject to ERISA and entitled to its protections. In this case, both the employees and the owner-employee and spouse are entitled to ERISA protection.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> In some instances, it may be desirable for a qualified plan to become subject to ERISA&rsquo;s rules and protections rather than the state law provisions that may be found to apply if ERISA does not preempt state law. In other instances, state law provisions that would otherwise govern may be preferable.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; DOL Reg. &sect; 2510.3-3(c)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Labor Dept. Advisory Opinion 92-21A (10/19/1992).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Raymond B. Yates Profit Sharing Plan v. Hendon, 541 U.S. 1 (2004).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> The proper classification of individuals by an employer as either employees or independent contractors is important in many areas, and an employer who misclassifies its workers will be responsible for the consequences of the misclassification.<br /> <br /> An employer who misclassifies an employee as an independent contractor may be liable for that employee&rsquo;s Social Security taxes because, in an employer-employee relationship, the employer is responsible for one-half of the tax owed, and the employer is responsible for deducting the employee&rsquo;s portion of the tax from wages.<a href="#_ftn1" name="_ftnref1">¹</a> Independent contractors, on the other hand, are liable for the entire amount of the tax, but are entitled to deduct one-half of the taxes paid (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8724">8724</a>).<br /> <br /> The IRS has ruled that if an employer wrongly classifies an individual as an independent contractor, the IRS can offset the refund of any self-employment taxes paid by that individual, but only with the employee portion of the employment taxes that would have been owed had the employee been properly classified.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Therefore, if an employer hires an independent contractor who is later found to be an employee, the employee can claim a refund for the self-employment taxes paid while the employee was erroneously believed to be an independent contractor. The IRS, when processing the refund, can reduce the amount refundable to the employee by the employment taxes the employee would have paid with proper classification. The employer, however, remains liable for the remaining balance that was refunded to the employee.<br /> <br /> The Tax Court has recently declined to apply a federal common law successor in interest standard in determining successor liability in the employment tax context. In this case, a taxpayer had been a partner in several partnerships that were later dissolved, with their assets (and certain operations) conveyed to a limited partnership in which that taxpayer became a limited partner. The IRS issued a notice of determination concerning worker classification, and attempted to collect employment taxes from the newly formed limited partnership as a successor in interest of the previously operating partnerships. While the Tax Court did agree with the IRS&rsquo; worker classification, it held that the newly formed limited partnership was not liable for the resulting employment tax deficiency as a successor in interest because it had not expressly assumed the liabilities of the previously existing partnerships. The limited partnership was, however, liable for employment taxes owing since the date it assumed the operations that were carried on by the dissolved partnerships. The court did note that the IRS could have possibly succeeded had it used a transferee liability theory in attempting to collect the employment taxes from the newly formed partnership.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Further, an employee who has been wrongly classified as an independent contractor may be entitled to claim benefits under the benefit plans that the employer has established for traditional employees. For example, the Ninth Circuit has held that certain &ldquo;leased&rdquo; employees that an employer leased from an employment agency, and sought to classify as independent contractors, could claim their rights to benefits under that employer&rsquo;s employee benefit plans (including health insurance coverage) if they qualified as employees under the 20-factor test laid out by the IRS in Revenue Ruling 87-41 (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8723">8723</a>).<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Similarly, in <em>Vizcaino v. Microsoft Corp</em>.,<a href="#_ftn5" name="_ftnref5">⁵</a> the Ninth Circuit held that individuals whom the employer sought to characterize as independent contractors may have had rights under the employer&rsquo;s benefit plans after an IRS audit found that the individuals were common law employees, and the employer conceded that it had mischaracterized the individuals.<br /> <br /> In contrast, the Tenth and Eleventh Circuits have held that the contract language of the employer&rsquo;s benefit plans will control. In these circuits, &ldquo;leased&rdquo; employees that met the 20-factor test to qualify as employees were <em>not</em> permitted to claim benefits under the employer&rsquo;s benefit plans when the plan language specifically excluded temporary and leased employees.<a href="#_ftn6" name="_ftnref6">⁶</a> This was the case even though the leased employees at issue performed substantially similar services as the employer&rsquo;s common law employees who qualified for plan benefits.<br /> <br /> Until this split in the circuits is resolved, it seems that the question of whether an employee who is wrongly characterized as an independent contractor is entitled to employment related benefits under the employer&rsquo;s benefit plans will be answered based on where the question is litigated.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Upon a request by a firm or worker, the IRS will determine whether a specific individual is an employee or independent contractor, provided the request is submitted for a tax year for which the statute of limitations on the tax return has not expired. A request is made by filing Form SS-8, <strong>Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding</strong>. Form SS-8 is filed to request a determination of the status of a worker for purposes of federal employment taxes and income tax withholding. A Form SS-8 determination may be requested only in order to resolve federal tax matters.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Treas. Reg. &sect; 31.3102-1(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; <em>See</em> <em>Beane v. Commissioner</em>, TC Memo 2009-152 (2009) and IRS ECC 201315023.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; TFT Galveston Portfolio Ltd. et al. v. Commissioner, 144 TC 9696 (2015).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; B<em>urrey v. Pacific Gas &amp; Electric Co</em>., 159 F.3d 388 (9th Cir. 1998).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; 97 F.3d 1187 (9th Cir. 1996).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; See <em>Bronk v. Mountain States Telephone &amp; Telegraph</em>, 140 F.3d 1335 (10th Cir. 1998); <em>Wolf v. Coca-Cola Co</em>., 200 F.3d 1337 (11th Cir. 2000).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; IRS Tax Topics No. 762.<br /> <br /> </div></div><br />