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Employee Vs. Independent Contractor Status - Revisiting in Light of the Affordable Care Act

Federal tax law has long-standing tests to determine whether a person is an employee or an independent contractor. Additionally, several years ago, Massachusetts enacted a more stringent test that employers in Massachusetts are required to follow.

With the enactment of the “Affordable Care Act,” (the Act), employers need to become more diligent in determining who is an employee versus an independent contractor. If a person that an employer considered to be an independent contractor is later determined to be an employee who should have been included in the Act’s required calculation of full-time equivalents (FTEs), certain consequences may apply. This is because the number of FTEs is important in determining if specific parts of the Act apply to an employer.

Federal tax law looks at various tests to determine employment status; however, the most important tests are the Employer/Employee Relationship Rule and the Control of Wage Payments Rule.

Employer/Employee Relationship Rule – The IRS uses various categories of evidence and analysis in evaluating this question including behavioral control, financial control and relationship of the parties. This analysis consists of a 20 part test that is used to evaluate the status of a worker. If an employer has the right to direct and control a worker’s performance both in respect to details (when, where, and how the work should be done) and the results of the work, then that worker is generally an employee. If a worker is the one controlling the performance of services, then the worker would be an independent contractor.

Control of Wage Payments Rule – The person or entity that controls a payment to a worker is considered the employer for purposes of this test. In the case of an employee, the employer pays the individual directly. If a third party pays the worker, then that third party is considered the employer with respect to the payment.
Let’s look at some examples:

EXAMPLE #1 

During certain times of the year, some companies need seasonal help to meet increased customer interactions. If a business hires these people, controls their job functions and pays them, the workers are employees. If a third party pays them (i.e. temp agency), then that third party is considered the employer.

EXAMPLE #2

A business hires a software consultant to do a special project. The person makes their own hours and may even conduct the entire project from a remote location. The person invoices the business and has other clients. This person is an independent contractor as the “employer” lacks control over the person’s duties.

Discussion of the state tax implications of the employer/employee relationship is beyond the scope of this article. Please note, that some states follow the federal rules but others have their own guidelines.