The Employee vs. Independent Contractor Determination

By Michael Siino  |  February 19, 2019

While the Tax Cuts and Jobs Act (TCJA) includes many new and revised provisions that continue to be extensively covered by tax professionals, other long-standing provisions of the tax code are gaining new relevance in light of how they may be affected by the TCJA. One such area, which has long been a topic of conversation between employers and those providing services for the employer (note how I was careful to not call such service providers “employees”) is whether to classify such workers as W2 employees or Independent Contractors. Let’s hone in on this a bit:

With the potential tax savings opportunities presented by the TCJA, now is a good time for both employers and workers to determine if they are appropriately classified. Specifically, in certain cases, an Independent Contractor (IC) may now have access to the new Section 199A passthrough deduction created under the TCJA, whereas the same benefit would not be available to an employee. While employers have historically been incentivized to treat workers as ICs for cost-savings reasons, it may now be a win-win scenario for both sides if they can determine that a worker fits the criteria of an IC, so it is time to revisit the distinction between the two classifications. But first, let’s look more closely at how the new deduction can benefit ICs:

• Subject to certain limitations, contractors receiving income through a partnership, S Corporation, Limited Liability Company or sole proprietorship may deduct up to 20% of qualified business income received through such entities. In other words, if a worker meets the tests to be treated as an IC, they may effectively reduce their effective tax rate on such income.

Before you jump to reclassify your position, know that the base criteria previously provided by the IRS in determining whether a worker is to be classified as an employee or IC remains the same, and the TCJA includes certain anti-abuse provisions which will not allow reclassification unless there has been a material change in facts and circumstances of the working relationship. For a worker taking on a new position, however, there may be significant tax savings that come along with an IC classification. To better understand the tests to be treated as an IC, visit IRS Publication 15A, which is updated yearly and includes a section titled, “Employee or Independent Contractor.” Though many of the determining factors are fact and circumstance based, they generally relate to control and who has the ability to direct the work that is performed.

If the criteria to be classified as an IC are met, the savings for both employers and ICs may be significant. Of course, the worker must consider the trade-offs, which can include the loss of a 401k match and health insurance and add on the responsibility of having to make estimated tax payments. Employers too must understand the risks of making a determination of employment status which may be challenged by the Department of Labor and IRS, resulting in additional financial liability for unpaid benefits, payroll taxes, etc. As is often the case with certain tax planning strategies, there are gray areas which must be examined to determine the weight of the benefit over the potential risk and cost. And, as always, carefully examine the facts and circumstances to determine the applicability of any tax planning opportunity.

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