ASK THE EDD ATTORNEY – IS THE LATEST IRS PRESS RELEASE A SIGN OF CHANGING EMPLOYEE VS. INDEPENDENT CONTRACTOR GUIDELINES? IF SO, ARE THE EDD GUIDELINES ALSO CHANGING?
By Robert S. Schriebman
On July 20, 2017 the IRS issued an important Fact Sheet (FS – 2017-9). On the surface, the purpose of the Fact Sheet was to remind employers how to properly classify workers. The Fact Sheet reminded employers that they could take advantage of the “Safe Harbor” provisions of section 530 of the Revenue Act of 1978 (P.L. 95-600). It also reminded employers about the Voluntary Classification Settlement Program that provides an opportunity to reclassify workers as employees for future tax periods.
In reviewing the Fact Sheet, I got the impression that the IRS was moving away from the well-known 20-factor test and providing fewer and broader guidelines. By the way, the EDD has a 23-factor test.
The Fact Sheet divided the guidelines into three broad categories: 1. Behavioral Control; 2. Financial Control; and 3. Relationship. Let’s take a look at each category.
According to the Fact Sheet, the right to direct and control work performance is of key importance, even if that right is not exercised. We know from previous articles on this website, that there is a degree of control in every business relationship and this minimum degree of control is not necessarily fatal. According to the IRS the new guidelines are as follows:
- The type of instruction given: such as, when and where to work, what tools to use, or where to purchase supplies. These factors may be fatal in establishing an independent contractor relationship.
- Degree of Instruction: the more detailed the instructions, the more likelihood that the worker is an employee.
- Evaluation Systems: these measure the details on how the work is to be done. If only the end results are evaluated, then the worker is likely to be an independent contractor.
- Training: periodic or on-going training about procedures and methods indicates an employee status.
There are five sub-factors most of which are part of the original 20-factor test such as, a significant investment in tools and equipment, rendering services to the public in general, and an opportunity for profit and loss. There are two new factors that you should know about:
- Unreimbursed expenses: independent contractors are more likely to incur unreimbursed expenses than are employees. This may be the case of expenses associated with vehicles or the replacement of tools and equipment. Most independent contractors are reimbursed for materials and supplies.
- Method of payment: independent contractors are more likely paid a flat fee or are paid by the job. Employees are generally paid a salary or an hourly rate. Employees are guaranteed a regular wage. Worker paid on commission may be treated as independent contractors. In California, there are specific statutes that allow independent contractor status.
According to the Fact Sheet the type of relationship depends upon how the worker and business perceive their interaction with one another. This could signal a change in how the IRS views the relationship by asking the parties involved whether the relationship was one of employee or independent contractor. Over the years I have seen many EDD audit reports where the auditor asks the worker how he or she perceives the relationship. However, when the worker answers “independent contractor” the EDD throws this aside and concludes that the worker is a common law employee! Will this IRS factor change the way the EDD does business? Who knows?
There are four sub-factors under this heading as follows:
- Written Contracts: This factor has always been part of the IRS 20-factor test, but it is not one of the EDD’s 23-factor test. In reality the EDD throws out most written contracts as being a “non-factor” – even contracts prepared by an attorney.
- Benefits: Providing standard employee benefits and perks have always been a strong indication that the worker is an employee. There is nothing new here.
- The permanency of the relationship: Most independent contractor relationships are not continuous. This is an important sign that the worker may be an independent contractor. However, some businesses, such as entertainment production companies tend to hire the same firms on a continuous basis. Firms that do staging, lighting, animation, and special effects tend to have a long and continuous relationship with the production company. On the other hand, a mover, plumber, or an electrician is on a as-needed basis.
- Services provided which are a key activity of the business: This is a change from the old “integration” standard that classifies a worker as an employee if the services are in any way related to the business. Now the IRS is painting a broader picture by using the word “key.” What does “key” mean? It’s anybody’s guess.
It all comes down to whether classifying an employee as an independent contractor with no reasonable basis for doing so, establishes the worker as an independent contractor. It’s going to be interesting to see how the IRS implements these new factors and whether the EDD will modify its 23-factor test to implement a broader and more liberal point of view. I am sure the future will have new articles on this website that will track both the IRS and the EDD and continue to keep you informed.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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