Are You an Employee or Independent Contractor?

June 27, 2011 by  Filed under: Taxes 

If you are working for someone or some organization, one of the most profound tax issues is whether you are an employee or independent contractor. For most work-related relationships, this may be obvious. However, for some occupations and work relationships, there may be some gray areas. There are various work relationships that are not straightforward. For example, some consultants and domestic workers may easily fall on either side. The IRS has gone to great lengths to differentiate between an employee and an independent contractor for tax purposes.

Rules for Differentiating Contractors and Employees

As a general rule, employees are people whose work is majorly controlled by the employer. Other rules that determine if a person is an independent contractor or not is whether one pays for the work-related tools and facilities, makes a profit or experiences loss from the work, can be fired by the employer, the longevity of the work arrangement, gets employee benefits, work is part of the business of the company, and the work relationship and understanding between the parties. In case of a disagreement between the IRS’s interpretation of the work relationship and what the taxpayer believes, a taxpayer can challenge the IRS’s view in Tax Court. The tax court will then determine, based on the facts of the work relationship, whether a taxpayer is an employee or an independent contractor.

Case in Point – Consulate Worker Determined as Employee

A trade officer in the British Consulate had been operating as an independent contractor until the IRS reviewed his returns and through their audits, determined that he was an employee. With the understanding that he was self-employed, the trade officer had deducted various expenses as business expenses from his taxable income and was participating in a Simplified Employee Pension (SEP) plan as a self-employed individual. However, the IRS insisted that he was an employee. The trade officer decided to raise the matter with the U.S. tax court. The officer had argued that there was no formal employment contract between himself and the British Consulate. Instead, the officer had a letter from the Consulate stating that the terms of his contract were on a self-employment basis as an independent contractor.

However, the Tax Court ruled that the officer was an employee, regardless of the letter from the Consulate. In the court ruling, the judge noted that the officer’s work was controlled by the Consulate as he had to attend meetings and was assigned other work responsibilities by the Consulate. He used to work for 40 hours a week for the Consulate and had a fixed salary. The court ruled that these factors showed that the contract was that of employment, even though the Consulate did not withhold any taxes from him. In the ruling, the court determined that failure of the Consulate to withhold taxes was tax neutral. The trade officer was, however, exempted from criminal charges as the court ruled that he reasonably believed that he was an independent contractor, based on the fact that he had consulted a tax preparer who had deemed him as such.

The bottom line: every taxpayer who is not sure about his or her work status should carefully review the IRS’s rules on employment and independent contractors to ensure that he or she is definitively an employee or a contractor. This way, he or she can file the correct tax returns and pay the required taxes in the appropriate category.

Rob L Daniel and partners of Limon Whitaker & Morgan, for years have helped businesses and individuals Nationwide, with their delinquent IRS & State tax problems. The firm is based in Los Angeles, California USA. / Tel:888.321.6188

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