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CRS REPORT EXPLAINS OBLIGATIONS, DEFINITIONS RELATED TO EMPLOYEE- INDEPENDENT CONTRACTOR DEBATE.

MAR. 8, 1993

93-297 A

DATED MAR. 8, 1993
DOCUMENT ATTRIBUTES
  • Authors
    Morris, Marie B.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    tax policy
    employment status, household workers
    employment status, independent contractors
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 93-12361
  • Tax Analysts Electronic Citation
    93 TNT 246-46
Citations: 93-297 A

                         HOUSEHOLD EMPLOYEES

 

 

                           Marie B. Morris

 

                        American Law Division

 

 

SUMMARY

The question whether a particular household worker is an employee or independent contractor can be important in many contexts. If the worker is an employee, the householder has certain employer's tax obligations. If the worker is self-employed, the worker has obligations under the tax laws. Different tax laws have different definitions of "employee" and "wages." These definitions determine coverage under the particular act. This report outlines some of the distinctions between employees and independent contractors, describes some of the tax obligations of the householder toward household employees, and lists some of the proposed bills to simplify the employer tax responsibilities.

DEFINITIONS

Classification of workers is important for a number of tax reasons:

o income tax withholding

o social security taxes (FICA or SECA)

o unemployment taxes (FUTA)

o participation in qualified pension and profit-sharing plans

o participation in other fringe benefit plans

o information return obligations.

For the household employer, the last three are usually of minimal importance.

If the worker is self-employed, the following results occur:

o the worker can deduct business expenses

o the worker has control over fringe benefits and retirement

o the worker must manage the business income and make quarterly tax payments

o the worker must pay both the employer and employee share of SECA

o the worker is not eligible for unemployment compensation.

Whereas, employees find that

o business expenses are often reimbursed

o fringe benefits (if any) are paid for

o half or all of FICA is paid for by the employer

o income taxes may be withheld from each paycheck of household employees (see Income tax withholding on pages 3-4)

o they are eligible for unemployment if they lose their jobs.

The Internal Revenue Service does not have a firm definition of the term "employee." For the most part, the IRS relies on tests which measure the degree of control that the person receiving the service has over the worker. Generally, the employer-employee relationship 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." IT IS NOT NECESSARY FOR THE EMPLOYER TO ACTUALLY CONTROL THE WAY THE WORK IS DONE; IT IS ONLY NECESSARY THAT HE HAVE THE RIGHT TO DO SO. Furnishing tools and a place to work are also indicia of an employer- employee relationship. Individuals who are subject only to direction as to results and not as to the methods to be used are not employees. Treas. Reg. section 31.3401(c)-1(b).

In Rev. Rul. 87-41,1987-1 CB 296, the IRS reprinted 20 factors that have been identified as indicating whether sufficient control is present to establish an employer-employee relationship. No single factor or number of factors controls the decision; all facts must be weighed to determine whether a particular individual is an employee or an independent contractor. The factors are listed below:

1. INSTRUCTIONS. Ordinarily, employees are required to comply with instructions concerning when, where, and how the work is to be done.

2. TRAINING. Training suggests that an employer wants the work performed in a particular manner.

3. INTEGRATION. Integration of services performed by the individual into the business' operations suggests an element of control.

4. SERVICES RENDERED PERSONALLY. The requirement that a certain person perform the task suggests that an employer is interested in methods used as well as results.

5. HIRING, SUPERVISING, AND PAYING ASSISTANTS. If the service recipient hires and supervises the assistants, this generally shows a degree of control over the workers on the job. However, if the worker hires, supervises, and pays the assistants under a contract where the worker agrees to provide materials and labor and under which the worker is responsible only for achieving a particular result, this suggests independent contractor status.

6. CONTINUING RELATIONSHIP. A continuing relationship suggests an employee-employer relationship.

7. SET HOURS OF WORK. Fixed hours of work suggest control.

8. FULL TIME REQUIRED. This impliedly restricts the worker from working for others.

9. WORKING ON EMPLOYER'S PREMISES. This suggests control over the worker.

10. SET ORDER OR SEQUENCE. The person who has the right to fix the order or sequence in which the work is performed is in control.

11. REQUIRED REPORTS. If regular reports are required, this suggests control over the worker.

12. PAYMENT BY HOUR, WEEK, MONTH. This generally indicates an employment relationship, but it may just be a convenient way of paying a lump sum agreed upon as the cost of the job.

13. REIMBURSEMENT OF BUSINESS OR TRAVELING EXPENSES. This ordinarily suggests an employment relationship.

14. FURNISHING TOOLS AND MATERIALS. If the service recipient furnishes tools or materials, this tends to show an employment relationship.

15. SIGNIFICANT INVESTMENT. If the worker has a significant investment in facilities that are used for performing services (e.g., an outside office), this tends to indicate independent contractor status. Lack of significant investment tends to show dependency on the person for whom the services are performed, i.e. employment.

16. REALIZATION OF PROFIT OR LOSS. A worker who can realize a profit or suffer a loss is generally an independent contractor.

17. WORKING FOR MORE THAN ONE FIRM AT A TIME. This generally indicates independent contractor status, but it is possible that the person can be the employee of more than one person.

18. MAKING SERVICE AVAILABLE TO GENERAL PUBLIC. Doing this on a regular and consistent basis indicates an independent contractor.

19. RIGHT TO DISCHARGE. The right to discharge a worker indicates that the worker is an employee and the person with the right to discharge is an employer.

20. RIGHT TO TERMINATE. If the worker can terminate his relationship with the person for whom the services are performed without liability, that factor indicates an employer-employee relationship.

The IRS takes the position that a domestic worker is the quintessential employee. Basically, the reason that a householder hires a maid, babysitter, housekeeper, handyman, gardener, or the like is to tell the person what needs to be done in the home. Unless the worker holds herself or himself out as being in business, or unless the worker is actually employed by another firm (e.g., a cleaning service), the IRS will view a domestic worker as the householder's employee. See PLR 8149010 and PLR 8106006 in which the IRS indicated that it was unaware of any court decisions or published rulings holding that a domestic worker in a private home was an independent contractor in situations where the taxpayer hired the worker directly.

INCOME TAX WITHHOLDING

Under Internal Revenue Code [IRC] section 3402, every employer making payment of wages is required to deduct and withhold income taxes on those wages. "Wages" is defined in IRC section 3401(a) to mean all remuneration (other than fees paid to a public official) for services performed by an employee for his employer with 20 statutory exceptions. Among the exceptions is a rule that household employers do not need to withhold on domestic employees unless requested to do so by the employee. IRC section 3401(a)(3); section 3402(p).

"Employer" in IRC section 3401(d) means "the person for whom an individual performs or performed any service, of whatever nature, as the employee of such person" except if that person does not control the payment of wages, "the term 'employer' means the person having control of the payment of such wages."

FICA TAXES

Federal Insurance Contributions Act (FICA) taxes are imposed on the income of every individual at a flat rate of 6.2 percent of wages (up to $57,600 in 1993) received from employment for old-age, survivors, and disability insurance under social security and at 1.45 percent (on wages up to $135,000) for hospital insurance (medicare). IRC section 3101. The tax is collected by the employer from the employee/taxpayer by deducting the amount of the tax from wages as and when paid. IRC section 3102. A matching tax is imposed on employers under IRC section 3111. IRC section 3121(a)(6) permits household employers to pay both halves of a domestic employee's FICA. Paying the employee's share does not create income for the employee.

Under FICA, the principal definitions which govern the obligation to deduct taxes are the definitions of "wages" and "employment." Wages do not include non-cash remuneration (e.g. meals and lodging) or cash remuneration of less than $50 per calendar quarter paid to an employee for domestic service in a private home of the employer. IRC section 3121(a)(7).

FUTA TAXES

The Federal Unemployment Tax Act imposes on every employer an excise tax with respect to having individuals in his employ equal to 6.2 percent of (the first $7,000 of) wages paid during the calendar year. Under IRC section 3306(a)(3), in the case of domestic service in a private home, "employer" means any person who during any calendar quarter (in the current or preceding calendar year) paid wages in cash of $1,000 or more for the service.

OTHER PROVISIONS

Chapter 25 of the IRC (section section 3501 et seq.) contains general provisions relating to employment taxes (FICA, FUTA, and income tax withholding). IRC section 3506 specifically provides that a person engaged in the trade or business of putting sitters in touch with individuals who wish to employ them is not considered the employer of the sitters. The section also provides that the sitters shall not be considered that person's employees. The statute does not spell out whether the sitters would be independent contractors or employees of the child's parents.

REPORTING REQUIREMENTS

Household employers need to obtain an employer identification number (EIN). This can be done by filing Form 55-4, Application for Employer Identification Number, with the IRS Service Center for their state, by telephoning 1-800-TAX-FORM, or by completing Form 942 and indicating "none" in the space which requests the EIN. Applications for EINs can be obtained from IRS or Social Security Administration offices.

When hiring a household employee, the employer needs the employee's social security number. The employer should furnish a Form W-4 to an employee who wants income taxes withheld and a Form W-5 to an employee who is eligible for advance payment of the earned income tax credit.

Household employers must file Form 942 quarterly by April 30, July 31, October 31, and January 31 of each year. By January 31, the employer must furnish each employee with a Form W-2. If the employer is liable for the FUTA tax (because of paying more than $1,000 of cash wages to an employee in any quarter during the current or previous year), Form 940-EZ or Form 940 must be filed annually by January 31. However, the tax has to be deposited at the end of any quarter when the cumulative FUTA tax liability is greater than $100. Deposits are made on Form 8109. Employers should contact their state employment office for information on how to file a state unemployment tax return and for a state reporting number. The state experience rate will affect the amount of federal unemployment taxes due.

Household employers will find that IRS Publications 926 (Employment Taxes for Household Employers) and 15 (Circular E Employer's Tax Guide) contain useful reference information on tax obligations and forms with which they need to be familiar.

PROPOSALS TO SIMPLIFY

Five bills introduced early in the 103d Congress would simplify the tax and reporting obligations of household employers.

o H.R. 13, section 901, H.R. 929, and H.R. 1114 would raise the threshold for reporting from $50 per quarter to $300 per year. They would permit household employers with no other employees to report and pay the employment taxes with their individual income taxes. The taxes would be subject to the estimated tax rules. The IRS would be authorized to enter agreements with the states to collect state unemployment taxes on domestic employees.

o H.R. 899 would raise the threshold for reporting to $200 per year, adjusted for inflation since 1950, and the amount would continue to be adjusted for inflation annually. (A rough estimate of the amount for 1992 would be slightly less than $2,000 per year.) The other provisions of the bill are the same as H.R. 13, H.R. 929, and H.R. 1114.

o H.R. 952 would raise the threshold for reporting to $245 per quarter and continue to adjust that amount for inflation after 1993.

DOCUMENT ATTRIBUTES
  • Authors
    Morris, Marie B.
  • Institutional Authors
    Congressional Research Service
  • Code Sections
  • Index Terms
    tax policy
    employment status, household workers
    employment status, independent contractors
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 93-12361
  • Tax Analysts Electronic Citation
    93 TNT 246-46
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