Restaurant owners, are you claiming your tax credit from your employees reported tip income?

If a restaurant owner chooses to participate, the credit may help the employer save hundreds of dollars each year per employee.

It is critical that business owners correctly determine whether an individual providing services to the business are independent contractors or employees.  The consequences of worker misclassification can be grave.  Besides owing back taxes to the IRS, the business will also owe state unemployment taxes and workers’ compensation premiums.  The business may also owe unpaid overtime or minimum wages, medical expenses, and unpaid vacation and sick pay.

 

Why Do Businesses Misclassify Workers?

Many businesses do not understand the applicable tests or do not properly apply the applicable tests.  In some cases, it is an intentional decision by the business to operate in a “gray area.”  There are many reasons why a business would prefer to classify a worker as an independent contractor rather than an employee.

• The business is not required to withhold income tax, pay social security and Medicare taxes, pay unemployment compensation taxes or provide worker’s compensation insurance for independent contractors.
• Independent contractors are not subject to minimum wage or overtime pay requirements.
• Independent contractors are not eligible to participate in employer sponsored health plans and retirement plans

 

Many businesses believe that the misclassification will only be discovered during a Federal or State government audit.  However, recently terminated workers and workers injured on the job are likely to retain attorneys and sue for unpaid overtime or for payment of medical expenses on the ground that they should have been classified as employees and not independent contractors.

 

A Multiplicity of Tests

Businesses that want to comply with the law can find it difficult due to the multiplicity of tests. Years ago, the IRS used a “twenty-factor common law test.”  Luckily around 2010, the IRS issued guidance that stated the IRS would use a three-part test, emphasizing the degree of control that an employer has over the worker.

The Department of Labor (DOL) enforces the Fair Labor Standards Act’s (FLSA) minimum wage and overtime provisions by using the “Economic Realities Test.”  The focus of the DOL test is the degree to which the worker is economically dependent upon the employer.

Finally, each state uses a test to determine eligibility for worker’s compensation and unemployment benefits.  Some state tests mirror either the IRS test or the DOL test, but many do not.

 

The IRS Test (The 3-Category “Control Test”)

The IRS guidance describes three broad categories of factors that need to be considered in applying the “Control Test”: behavioral control, financial control, and the relationship of the parties.

1. Behavioral Control covers facts that show if the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.

2.    Financial Control covers facts that show if the business has a right to direct or            control the financial and business aspect of the worker’s job.  This includes:

1. 1. The extent to which the worker has unreimbursed business expenses
   2. The extent of the worker’s investment in the facilities or tools used in performing services
   3. The extent to which the worker makes his or her services available to the relevant market
   4. How does the business pay the worker (by the hour? By the job?), and
   5. The extent to which the worker can realize a profit or incur a loss

3.    Relationship of the Parties covers facts that show the type of relationship the              parties had.  This includes:

1. 1. Written contracts describing the relationship the parties intended to create
   2. Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
   3. The permanency of the relationship, and
   4. The extent to which services performed by the worker are a key aspect of the regular business of the company

 

The DOL Test (6-Factor “Economic Realities” Test)

On July 15, 2015, the DOL issued “Administrator’s Interpretation No. 2015-1,” a 15-page document describing the “Economic Realities Test” under the FSLA and the origins of the Economic Realities Test.  The DOL describes the 6 factors that must be considered to determine whether a worker is an independent contractor or an employee under the Economic Realities Test:

1. The extent to which the work performed is an integral part of the employer’s business
2. The worker’s opportunity for profit or loss depending on his or her managerial skill
3. The extent of the relative investments of the employer and the worker
4. Whether the work performed requires special skills and initiative
5. The permanency of the relationship
6. The degree of control exercised or retained by the employer

The underlying theme of the DOL’s Economic Realities Test is that true independent contractors are in business for themselves, deciding which jobs to take, how much to charge, and when and how to do the work.  Whether they succeed or fail in their chosen business is fundamentally within their own control.  By contrast, a worker who is economically dependent on the company for whom he or she is working, is not really in business for him or herself, but is an employee.

 

State Tests

About a third of the 50 states use the “A-B-C Test” to determine whether a worker is an independent contractor:

1. The worker must be free from direction and control in connection with the performance of the service;
2. The worker’s service must be performed either outside the usual course of business of the employer and outside the employer’s places of business (some states only require one of these); and
3. The worker must be customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the service performed.

 

Contact your A Plus Payroll representative for more information concerning worker classification.