Tax Treatment of Employees and Self-Employed Persons by the Internal Revenue Service

The definition of who is an employee and who is self-employed is not clear. The definition is generally based on common law in which the determining factor is the degree of control, or right of control, the employer has over the worker. If workers are employees, their employers must withhold and pay to the government income and social security taxes, contribute to the social security fund, and, in most instances, pay an unemployment insurance tax.

When the Internal Revenue Service (IRS) determines that persons have been misclassified as self-employed, the effects are that: (1) employers can be retroactively assessed employment taxes for 3 current tax years; (2) double taxation can occur when the employer and employee pay income and social security taxes on the same income; and (3) self-employment retirement plans established by taxpayers can be declared invalid. Alternative proposals for Congress to develop statutory language to clarify definitions of employee and self-employed or to provide legislative relief from retroactive tax assessments were all found to be inadequate. A primary source of controversy has been the IRS interpretation of the common law definition of an employee in a way that considers persons operating separate businesses as employees of another business because one can exercise some control over the other.

Recommendations

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