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Employee vs. Independent Contractor: Common-Law Test in Minnesota

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One of the most crucial distinctions in employment and tax law is one made between employees and independent contractors. The applicability of a whole host of labor and tax provisions hinges on how the worker is classified. In Minnesota, most statutory provisions that deal with these issues (including Minnesota Unemployment Insurance) incorporate in one way or another the common-law test factors adopted by the courts to classify workers. In this essay, I will list and explain each of the five factors for determining whether a worker is an employee or an independent contractor.

Common-Law Test

The common-law test consists of five factors. The two most important factors are: the right to control the means and manner of performance and the right to discharge a worker. The presence of one factor is insufficient to find employment relationship if such factor is countered by other factors. Instead, the courts look at the overall relationship between the parties in order to determine whether a master-servant – this is the so-called “totality of circumstances” approach.

Let us review each of the five factors in more detail.

1. The Right to Control the Means and Manner of Performance

This is one of the two most important factors (right to discharge is another) in the test. If the employer has the right to control how a worker performs his job, then the worker is likely to be classified as an employee. In Minnesota, it is important to distinguish between control over “means and manner” versus control over the “end-product.” In the latter case, the employer control the end result of the worker’s product, not the manner in which the worker was able to achieve this result. Therefore, such control does not evince a master-servant relationship, but, rather, is characteristic of an independent contractor status.

2. The Mode of Payment

The most important issue here is whether the worker is paid on a per job basis or on a basis more akin to an employer-employee relationship (such as payment per hour or fixed salary). Payment based on a job evinces an independent contractor relationship, whereas payment per hour indicates an existence of a master-servant contract.

3. Furnishing of Materials and Tools

An employer-employee relationship is more likely where the employer furnishes all materials and tools necessary for the worker to do his job. On the contrary, if the worker supplies all of his tools and materials, then the court will be inclined to rule that this factor indicates that an independent contractor relationship exists.

4. Control of Premises Where Work Is Performed

Where the services are performed on the premises controlled by the employer, a court may adopt a position that this situation implies that employer exercises control over worker (though, there exceptions). On the other hand, if the worker controls the premises where the work is performed , it is usually indicative that the worker enjoys at least some freedom from the employer’s control. It is important to point out, however, that in some professions where the work is necessarily done outside of the employer’s premises, the worker’s control of the place of work loses its importance.

5. Right of Employer to Hire and Discharge

The right to discharge is the other most important factor in determining whether there is an employer-employee relationship. Where a worker may be terminated by the employer with little notice, without cause, or for failure to follow specified rules or methods, and the employer does not incur any liability as a result of such termination, the court is likely to find that a master-servant relationship exists. On the other hand, if the worker cannot be terminated without the employer being liable for damages (assuming the worker is producing according to his contract specifications), the court is more likely to determine that there is an independent contractor relationship between the parties.

The foregoing is a very simplified overview of the common-law test. The actual analysis may be much more complex, especially when applied to a specific set of facts. Remember, the common-law test emphasizes the “totality of circumstances” approach which is necessarily involves a fact-driven analysis.

Codification of the Common-Law Test

It is also important to emphasize that, in most areas of law, the Minnesota legislature codified the common-law test with significant alterations, adding and deleting various factors. For example, Minnesota Unemployment Insurance administrative rules list more than a dozen factors just to determine whether there is a right to control the means and manner of performance. Moreover, the Rules detail eight factors to consider in addition to the modified common-law test.

Often, the common-law test is modified according to specific circumstances of a relevant industry. For example, the specific factors for the construction and trucking industries will vary significantly from the rules that apply to non-emergency medical transportation, even though the common-law test still constitutes the basis for the divergent rules.

Furthermore, one should remember that several different tests may apply to the same situation depending on the government agency that makes the determination of an employment relationship. For example, the IRS applies a different test than the Minnesota Department of Commerce (the “DOR”), and, in turn, the DOR’s rules differ from the factors adopted by the Minnesota Unemployment Insurance. Yet, all three agencies are trying to find an answer to the same question – whether a worker should be classified as an employee or an independent contractor.

Conclusion

In applying the common-law test, whether modified or not, you should hire an attorney familiar with these rules. Lawyers usually have the necessary familiarity with the rules, training in legal research, and experience in dealing with the government agencies.

Sherayzen Law Office is a law firm with a tested experience in the area of worker classification. We can help you make sure that you are in compliance with existing laws and regulations, draft the necessary documents (such as an Independent Contractor Agreement), and defend your interests in the administrative and judicial courts.

Call NOW to speak with an experienced business attorney!

Claiming New Health Care Tax Credit: Draft Form 8941

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On September 7, 2010, the Internal Revenue Service released a draft version of the form 8941 that small businesses and tax-exempt organizations will use to calculate the small business health care tax credit when they file income tax returns next year.

The small business health care tax credit was created as part of the Affordable Care Act. In 2010, the credit is generally available to small business employers that contribute an amount equivalent to at least half the cost of single coverage towards buying health insurance for their employees. For tax years 2010 to 2013, the maximum credit is 35 percent of premiums paid by eligible small business employers and 25 percent of premiums paid by eligible employers that are tax-exempt organizations. Beginning in 2014, the maximum tax credit will go up to 50 percent of premiums paid by eligible small business employers and 35 percent of premiums paid by eligible, tax-exempt organizations for two years.

The maximum credit goes to smaller employers, defined as small businesses that employ ten or fewer full-time equivalent (FTE) employees, paying annual average wages of $25,000 or less. The credit is completely phased out for employers that have 25 FTEs or more or that pay average wages of $50,000 per year or more. Because the eligibility rules are based in part on the number of FTEs, and not simply the number of employees, businesses that use part-time help may qualify even if they employ more than 25 individuals.

The final version of Form 8941 and its instructions will be available later this year.

Business Tax Lawyers Minneapolis | IRS Classification of Workers

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Determining the business relationship between your business and your workers can be one of the most important aspects of your business and tax planning. The consequences of worker mis-classification can carry a heavy penalty for your businesses, including liablity for employment taxes for misclassified workers.

There are many various competing definitions of how a worker should be classified, including specialized formulas developed by states for particular industries (for example, construction and trucking industries in Minnesota). In this essay, however, I will only generally describe the classifications used by the U.S. Department of Treasury, particularly the IRS.

There are four classification categories used by the IRS: common-law employees, statutory employees, statutory nonemployees, and independent contractors.

Common-Law Employees

The IRS states that, under common-law rules, anyone “who performs services for you is your employee if you have the right to control what will be done and how it will be done.” (See IRS Publication 15-A) The most important factor here is the right to control the details of how the services are performed. I will not further deal here with the specific factors of common-law employment and how it is distinct from the independent contractors (this discussion is left for a later article).

Remember, if you have an employer-employee relationship, it makes virtually no difference how it is labeled. The substance of the relationship, not the label, governs the worker’s status. Nor does it matter whether the individual is employed full time or part time. Finally, the IRS makes no distinction between classes of employees: superintendents, managers, and other supervisory personnel are all employees.

An officer of a corporation is generally an employee; however, an officer who performs no services or only minor services, and neither receives nor is entitled to receive any pay, is not considered an employee. Id. A director of a corporation is not an employee with respect to services performed as a director.

Leased workers (i.e. workers supplied by a firm to other firms) are considered “employees” of the firm furnishing the workers for the employment tax purposes. This situation usually arises with respect to temporary staffing agencies.

The most important consequence of this classification for tax purposes is the fact that the employer is usually required to withhold and pay income, social security, and Medicare taxes on wages that the employer pays to its common-law employees. There are a number of exceptions such as some religious employees.

Statutory Employees

Some classes of workers are considered as employees by the Federal Code (and, hence, the IRS) regardless of whether they may qualify for an independent contractor status under the common-law rules. This means that the employer should treat the worker as its employee and pay the necessary payroll taxes, while the worker may be able to report their wages, income, and allowable as if he were self-employed (using schedule C (or schedule C-EZ)). Statutory employees are not liable for self-employment tax because their employers must treat them as employees for social security tax purposes.

A worker is considered by the Federal Code as a “statutory employee” if he falls within any one of the listed four categories. The categories are defined as follows:

1. A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is agent of the business employer or is paid on commission;

2. A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company;

3. An individual who works at home on materials or goods that the business employer supplies and that must be returned to the business employer or to a person the business employer names, if the business employer also furnish specifications for the work to be done; and

4. A full-time traveling or city salesperson who works on the business employer’s behalf and turns in orders to the employer from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for the business employer must be the salesperson’s principal business activity.

If the worker falls within one of the categories of statutory employment above, the employer should withhold social security and Medicare taxes from the wages of statutory employees only if all three of the following conditions are met:

a. The service contract states or implies that substantially all the services are to be performed personally by the worker;

b. The worker does not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities); and

c. The services are performed on a continuing basis for the same payer.

FUTA (federal unemployment tax) tax may be imposed only with respect to workers who fit into categories 1 and 4 above. The main reason is because the term “employee” for FUTA purposes does not include statutory employees in categories 2 and 3 above.

Remember, an employer should not withhold federal income tax from the wages of statutory employees.

Statutory Nonemployees

Under the Federal Code, there are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Direct sellers and licensed real estate agents are treated as self-employed for all federal tax purposes, including income and employment taxes, if:

a. Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked; and

b. Their services are performed under a written contract providing that they will not be treated as employees for federal tax purposes.

Independent Contractors

The final classification category is an independent contractor. The definition of an independent contractor can be complex and is a proper subject of another essay. Generally, however, an individual is an independent contractor if the employer (i.e. the person for whom the services are performed) has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Usually, lawyers, contractors, subcontractors, auctioneers, and other workers who follow an independent trade, business, or profession in which they offer their services to the public, are not employees. However, whether such people are employees or independent contractors depends on the facts in each case.

Conclusion

Determining the business relationship between your business and your workers can be a very complex issue fraught with dangers. Moreover, even if you comply with the regulations above and correctly classify your workers for federal tax purposes, this does not necessarily mean that your federal compliance will be sufficient to satisfy the conflicting requirements of the various state classification rules. Since the consequences of mis-classification can be very serious, it is advisable that you seek an attorney’s advice on these issues.

Sherayzen Law Office can help you correctly classify your workers and make sure that your business follows the necessary and advisable procedures to comply with various, often conflicting, state and federal regulations.

Contact Mr. Sherayzen to discuss your business situation.

Estimated Tax Payments are due on September 15, 2010

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Estimated tax payments for the third-quarter (June 1-August 31) of 2010 are due on September 15, 2010. The estimated tax payments should be made using Form 1040-ES. Note, if the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be considered on time if it is made on the next business day.

FBAR: Financial Interest, Signature Authority, and Other Comparable Authority

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One of the major requirements that gives rise to the obligation to file the FBAR is that a U.S. person has either a financial interest in, or a signature authority or other comparable authority over the relevant foreign financial accounts. In deciding whether the FBAR is required, it is useful to go through all three of these requirements in order.

First, the filer needs to determine whether he has a financial interest in the account. If the account is owned by an individual, the financial interest exists if the filer is the owner of record or has legal title in the financial account, whether the account is maintained for his own benefit or for the benefit of others, including non-U.S. persons. See 75 Fed. Reg. at 8847. Hence, if the owner of record or holder of legal title is a U.S. person acting as an agent, nominee, or in some other capacity on behalf of another U.S. person, the financial interest in the account exists and this agent or nominee needs to file the FBAR. If a corporation is the owner of record or the holder of legal title in the financial account, a shareholder of a corporation has a financial interest in the account if he owns, directly or indirectly, more than 50 percent of the total value of the shares of stock or has more than 50 percent of the voting power. Id. Where a partnership is the owner of record or the holder of legal title in the financial account, a partner has a financial interest in the financial account if he owns, directly or indirectly, more than 50 percent of the interest in profits or capital. Similar rule applies to any other entity (other than a trust) where a U.S. person owns, directly or indirectly, more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits. Id. Special rules apply to trust and can be found in the Proposed Regulations. Id. Finally, a U.S. person who “causes an entity to be created for a purpose of evading the reporting requirement shall have a financial interest in any bank, securities, or other financial account in a foreign country for which the entity is the owner of record or holder of legal title.” Id.

If there is no financial interest in the foreign financial account, the filer should determine whether he has signature authority over the account. A U.S. person has account signature authority if that person can control the disposition of money or other property in the account by delivery of a document containing his signature to the bank or other person with whom the account is maintained. See 75 Fed. Reg. at 8848. Notice, once again, that control over the disposition of assets in the account is one of the main factors in deciding whether the FBAR needs to be filed.

It is important to mention that, pursuant to the IRS Announcement 2010-23, persons with signature authority over, but no financial interest in, a foreign financial accounts for which an FBAR would otherwise have been due on June 30, 2010, will now have until June 30, 2011, to report those foreign financial accounts. Combined with IRS Announcement 2009-62, this means that the deadline has been extended for the calendar year 2009 and all prior years.

Finally, even if no financial interest or signature authority exists, the filer has to continue his analysis and determine whether he has “other comparable authority” over the account. This catch-all, ambiguous term is not defined by the IRS. Nevertheless, the instructions to FinCEN Form 114 formerly Form TD F 90-22.1 generally state that the other comparable authority exists when the filer can exercise power comparable to the signature authority over the account by communication with the bank or other person with whom the account is maintained, either directly or through an agent, or in some other capacity on behalf of the U.S. person.