Monday, April 1, 2013

Recently the IRS released a ruling from the Tax Court in New York regarding a general contractor and independent contractors. This ruling gives us some insight into how the court evaluates the merits and rules around independent contractors.

Let's start with the facts as agreed to by both the contractor and IRS.

1. The general contractor preformed 20 - 30 construction projects in 2005.

2. The general contractor utilized 29 individuals to preform services on those projects during 2005.

3. The individuals did not work for the general contractor full time during 2005 but only on certain projects.

4. Some of the individuals employed as independent contractors worked for the general contractor in all four quarters of the year while others worked 3 or less.

5. The general contractor contracted with individual homeowners to complete certain construction projects. The independent contractors assigned to the project did not have any direct contact with the homeowner.

6. The independent contractors did not work under business names or advertise to the public.

7. The general contractor supervised the workers, he told the workers what work needed to be completed and set deadlines for the jobs.

8. The general contractor paid each independent contractor a flat fee each week according to the percentage of the work completed. Checks were made payable to the individuals.

9. The workers set their own hours and work schedules. The general contractor visited sites once a day or every other day.

10. The general contractor did not tell the independent contractors how to do their job, but would replace independent contractors if a deadline was in danger of not being met.

11. General contractor would occasionally transport independent contractors between worksites if the independent contractor was working on more than one project at a time.

12. The independent contractor provided their own small hand tools, but the general contractor provided larger tools.

13. The general contractor did not provide any office space or administrative assistance to the independent contractors.

14. The general contractor did not provide any type of insurance or employee benefits to the independent contractors.

15. The general contractor did not file any 1099's, W-2's or 941 forms for the year in question.

The Tax Court reviewed all the factors and weighed their merit in classifying the workers as employees or independent contractors. It is interesting to see how the court ruled on each issue. Here is a summary of their analysis and how they evaluated its impact on the workers classification.

1. The general contractor failed to prove that he did not control the work of the independent contractors. His visits to the site on a daily or every other day basis and the setting of deadlines demonstrated a "behavioral control" aspect to the relationship. Status - Employee

2. The general contractor approved the quality of the independent contractors work and paid them on a weekly basis. This introduced a "financial control" aspect to the relationship. Status - Employee

3. The general contractor paid each sub-contractor a negotiated flat fee, insulating the independent contractor from a "risk of loss". This is an indication of "financial control". Status - Employee

4. The general contractor replaced workers whose work was not approved or who were not meeting the set deadlines. This was deemed to be an indication of "type of relationship" meaning it looked like an employee/employer arrangement. Status- Employee

5. One worker testified that the independent contractors understood they were not employees. Status – Independent Contractor

6. The independent contractors provided their own small tools and were reimbursed for any materials or supplies purchased for the job. Status – Independent Contractor

7. The independent contractors were deemed to be and "essential part" of the general contractors business and that he could not have completed the number of projects in that year without the assistance of the workers. Status – Employee

8. Only 7 of the independent contractors worked for the general contractor all four quarters and all independent contractors had the freedom to work for other general contractors. Status – Independent Contractor

The factors weighed in favor of treating the independent contractors as employees. At stake was $23,974.16 in FICA taxes, $8,572.37 in FUTA and $6,743.46 in FIT. This does not include penalties or interest that will be assessed.

The ruling seems to indicate that the Tax Court put significant weight on the issue that the contractors did not hold themselves out as a business, did not have any "risk of loss", and could be replaced if the general contractor did not like their work.

In addition the court ruled that the contractor was not eligible for Section 530 relief because he did not file the appropriate 1099 forms for the year in question.

This ruling gives us a deeper insight to how critical the classification of independent contractors is to a business and the detail the IRS and Tax Courts will use in making a determination. Not only does the company now face the tax payments but the penalties and interest. In Publication 15 the penalties are identified as:

If the employer issued required information returns, the section 3509 rates are:



For social security taxes; employer rate of 6.2% plus 20% of the employee rate (see the Instructions for Form 941-X).

For Medicare taxes; employer rate of 1.45% plus 20% of the employee rate of 1.45%, for a total rate of 1.74% of wages.

For Additional Medicare Tax; 20% of the employee rate of 0.9%.

For income tax withholding, the rate is 1.5% of wages.



If the employer did not issue required information re-turns, the section 3509 rates are:



For social security taxes; employer rate of 6.2% plus 40% of the employee rate (see the Instructions for Form 941-X).

For Medicare taxes; employer rate of 1.45% plus 40% of the employee rate of 1.45%, for a total rate of 2.03% of wages.

For Additional Medicare Tax; 40% of the employee rate of 0.9%.

For income tax withholding, the rate is 3.0% of wages.



Please forward this to any company involved in the construction trades, as this is the number one industry the IRS targets for independent contractor violations.

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