If you are among the many owner/doctors making use of or considering someone for contract labor (i.e., independent contractors such as dental hygienists, subcontracted doctors, in-house lab techs, etc.) in lieu of full-time or part-time employees, read this article so that you can determine whether you are legally within government guidelines.
Many doctors/owners have achieved their objective of reducing labor costs (direct wages and employee benefits) by either hiring workers as independent contractors or terminating existing employees and rehiring them as independent contractors. An advantage of labeling a worker as an independent contractor is that it lowers an employer’s tax obligation since the employer does not have to pay the independent contractor’s Federal Insurance Contribution Act (FICA) or Federal Unemployment Tax Act (FUTA) taxes. In addition, the employer is not required to provide employee benefits (workers’ compensation insurance, vacation pay, sick leave, health insurance, pension contributions, etc.) to independent contractors.
Whatever the reason, the use of contract labor is common among doctor/owners of all types and sizes of practices, and its use is growing. Because of the increased usage of contract labor by employers, the IRS and state employment departments have increased their scrutiny of contract labor status. There can be major legal and tax risks if employers violate the IRS’s definitions of an employee and an independent contractor. Therefore, it is critical that you, the doctor/owner, correctly determine whether the individuals providing services are employees or independent contractors.
Independent Contractor – IRS Definition
The IRS has specific guidelines on determining the status of a worker. Treasury Regulation 31.3401(c)-1(b) states: “Generally, the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so.”
Treasury Regulation 31.3401(c)-1(b) lists a twenty-question test that the IRS uses in determining the worker’s correct classification status. These questions include:
1. Is the worker required to follow your instructions in completing the job or accomplishing the task?
2. Do you provide the training necessary for completion of the job?
3. Are the worker’s specific personal services required for successful completion of the job?
4. Are the worker’s services crucial to the success or continued existence of your company?
5. Do you set work hours?
6. Does worker have a continuing relationship with your company?
7. Do you hire, supervise, or pay the worker’s assistants?
8. Is worker precluded from seeking employment elsewhere?
9. Do you specify the location where the work must be performed?
10. Do you direct the order or sequence of tasks to be performed?
11. Do you require progress reports?
12. Is the worker paid by the hour, week, or month, rather than for the completion (or stage of completion) of the project?
13. Does the worker work only for your company?
14. Do you pay business overhead and incidental expenses?
15. Do you provide equipment, tools, and materials?
16. Is the work performed on your premises or using your facilities?
17. Are the worker’s services not available to the general public?
18. Do you provide a minimum “salary” and therefore shield the worker from the risk of profit or loss?
19. Do you have the right to terminate the worker even if the job results are achieved?
20. Are you required to pay the worker for time spent even if the job is not completed?
The more “Yes” answers that you have to the above questions, the more likely you have an employer/employee relationship and not an owner/independent contractor relationship.
Misclassification of Employees and Consequences
If companies misclassify their workers, they risk getting audited by one or more government agencies including the Department of Labor, Social Security Administration, Workers’ Compensation Offices, and Internal Revenue Service (IRS). If the IRS finds a company guilty of misclassifying its workers, the IRS might require the company to pay all back withholding taxes plus interest, even if the misclassified independent contractors have already paid their taxes. The IRS might also levy huge fines and press criminal charges against company owners. In addition, misclassified or disgruntled independent contractors may later allege that an employer-employee relationship existed in an attempt to hold the employer liable for withholding and payroll taxes. They have successfully sued employers for unemployment insurance, stock options, overtime pay, retirement benefits, profit sharing, disability payments, workers’ compensation and more.
Business owners must weigh all of these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. Remember, by law, an employer cannot classify a worker as an independent contractor and then dictate when, where, and how that worker works. It’s all about degree of control and independence.
For more information, refer to Publication 15-A (PDF), Employer’s Supplemental Tax Guide at http://www.irs.gov/publications/p15a/index.html or Publication 1779 (PDF), Independent Contractor or Employee. If you want the IRS to determine whether a specific individual is an independent contractor or an employee, file Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. If you do hire the services of an independent contractor, you must file Form 1099-MISC, Miscellaneous Income, to report payments of $600 or more to persons not treated as employees (e.g., independent contractors).
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©2012 Tracker Enterprises, Inc. ™
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Dr. Pavlik and Tracker Enterprises, Inc. assume no responsibility for business decisions made by the reader. It is recommended that the reader also seek legal, accounting, or financial planning advice before making any business decisions.