200.1 - Introduction
An "employee" is anyone who performs a service for the University while working under the direction or control of the University or a University faculty/staff member. IRS regulations state that when an employer has the right to control both (a) the results of the worker's labor, and (b) the means and methods used by the worker to achieve the results, direction or control of the worker by the University can be deemed to exist. [1] Employees are paid via the payroll process.
An "independent contractor" is anyone who is engaged by the University to perform a specific function or task. In contrast to an employee, an independent contractor is free to use his/her discretion in determining the means and methods of accomplishing the function or task. Independent contractors are paid via the accounts payable process, and no taxes are required to be withheld on the amount paid. [2] Because the IRS puts the burden of proof on the University regarding independent contractor status, a written agreement or contract specifying the function/task to be performed and the lack of control over means and methods is highly recommended.
200.2 - The 20-Factor Test
Whether an individual is an employee or an independent contractor is often a complex question. The IRS has come up with 20 factors to be considered in making this determination. The 20 factors are:
- Worker is required to comply with instructions about when, where, and how work is done.
- Worker needs to be trained.
- Worker's tasks are integrated into normal business operations.
- Worker's services must be personally rendered.
- Worker is not responsible for hiring, paying, or supervising assistants.
- Worker has continuing relationship with "employer".
- Working hours are set by "employer".
- Worker is required to devote full-time efforts to "employer's" business.
- Worker must perform or execute duties on "employer's" premises.
- Worker's services must conform to order or sequence set by "employer".
- Worker is required to submit regular oral or written reports.
- Worker's payment is based on time spent instead of by the job.
- Worker is reimbursed for travel and other expenses.
- Worker is furnished tools, materials, and other equipment by "employer".
- Worker has no significant investment in facilities (such as an office).
- Worker has no risk of real economic loss.
- Worker is not working for more than one "employer" at a time.
- Worker does not make services available to the general public.
- Worker is subject to discharge without "employer" penalty -- even if job specifications are met.
- Worker can terminate relationship with "employer" without worker liability.
"Yes" answers indicate employee status. [3] There is no magic number of "yes" answers that will cause an individual to be considered an employee rather than an independent contractor. However, the more "yes" answers, the more likely the IRS will consider the individual an employee. To assist in making the determination, use the independent contractor checklist (short form), along with the determination flowchart. If questions remain, use the independent contractor checklist (long form) and/or contact the Director of Finance.
200.3 - Specific Issues for Higher Education
Over the years, the IRS has begun to focus attention (inquiries and audits) on some specific topics unique to higher education. Some of the scrutinized payments to individuals include:
- Adjunct and part-time faculty. These individuals are considered employees due to the elements of control existing in the relationship between the University and the faculty. [4] However, this is not so cut-and-dried with respect to instructors of Continuing Education and other non-credit courses.
- Outside contract payments to coaches. This includes payments to coaches for conducting summer camps.
- Instructors in non-degree professional development programs.
- "Consultants" or other "independent contractors" who perform management/supervisory functions.
- Individuals with excessively low withholding.
- Independent contractors paid more than $5,000 in a year.
- Payments to nonresident aliens. Nonresident aliens may not be paid as independent contractors, and there are other limitations on the types of payments they may receive. See Payments to Foreign Citizens for additional guidance.
- Workers considered both an employee and a contractor. This situation may arise in very unusual circumstances where the function or task being performed is very far-removed from an employee's "normal" duties. For example, if an employee is a member of a theater troupe hired to perform at a University event, the employee might be considered an independent contractor with respect to the payment for performing. However, the IRS generally takes the position that if an employee performs any service for his/her employer, all payments to that employee should be treated as wages.
200.4 - Impact of Misclassifications
Misclassification of an individual as an independent contractor instead of as an employee can have significant negative financial repercussions for the University. If a misclassification is intentional, the IRS will assess federal income taxes of 20% and Social Security/Medicare taxes of 15.3%. Penalties and interest may also be assessed. Typically, this assessment is made against the University, not the individual in question. This is true even if the individual has paid the taxes.
In addition, if an individual is reclassified as an employee, the individual may become eligible for various University fringe benefits, including retirement plans, life and health insurance, etc. Potentially, if there are very egregious misclassifications, the University's retirement and deferred compensation plans may be penalized or be disqualified. Disqualification means employee contributions to the plans would be made on an after-tax basis rather than pre-tax.
Notes:
[1] Treasury Regulation Sec. 31.3121(d)-1(c)
[2] Reg. Sec. 31.3401(c)-1(b)
[3] IRS Revenue Ruling 87-41, 1987-1 CB 296
[4] Technical Advice Memorandum 9105007
The WUTH is presented here in HTML format. Click on the links in the link box on the right to go to a specific section of the handbook. A printable version of the handbook in PDF format will be forthcoming in the future. Significant portions of the WUTH are adapted from The Texas A&M University System Tax Manual, the nonresident alien tax websites of Towson University, Cornell University, and The University of Missouri, and information provided by Arctic International LLC.