The purpose of this page is to provide hiring managers a basic understanding of IRS requirements and a procedure for ensuring that individuals hired or contracted to perform services are properly classified either as employees or as independent contractors.
Individuals performing services for PAFA will be considered employees unless a determination is made in advance of any commitment for services that such individuals are appropriately classified as independent contractors. To make that determination, PAFA will adhere to the 20 common-law factors set forth by the IRS. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed.
Common Law Rules
A set of “Common Law Rules” provides characteristics and classifications that help differentiate the work of an employee from that of an independent contractor. These fall into three categories:
- Behavioral Control
- Financial Control
- Type of Relationship
In determining whether to engage an individual as an independent contractor, the hiring department must assess the work in these three areas to determine the proper status of the individual.
While typically a contractor’s work has no controls by PAFA, it is possible that one or more control may be present without coming under the full direction of PAFA. For example, a contractor may work during PAFA office hours (indicating an employee relationship), but the individual maintains contractor status by being able to work at other times if he or she chooses. The individual may work solely for PAFA at the time (a possible employee relationship), but they maintain contractor status by being able to solicit business from other clients while performing services for PAFA.
Determining Method of Payment
Two determinations must be made before engaging a person in work for which PAFA is to pay the person: Is the person an employee or an independent contractor? Is the person a U.S. citizen or resident, or is the person a non-resident foreign national?
Proper classification of individuals is critical to appropriately process and make payments for services. Under the United States Internal Revenue Service (IRS) and other agency guidelines, PAFA has certain responsibilities. Independent contractor payments must be tracked for taxable income reporting on Form 1099, and employee payments are subject to employment taxes and are reportable on Form W-2. In addition, employees may be eligible for benefits. Errors in employee/non-employee classification may lead to significant fines and penalties due to lack of appropriate income reporting, tax withholding, or provision of benefits.
Roles and Responsibilities
Hiring Manager: Hiring manager selects an independent contractor and ensures that the contract is in accordance with the PAFA Independent Contractor template. Hiring managers should first consider the following two questions: 1) Does the pay as employees others who perform essentially the same duties that are to be performed by this worker? 2) Has this worker previously been paid as an employee to perform essentially these same tasks?
- Discuss the scope of work with HR to determine whether employee or independent contractor.
- If the independent contractor determination is made, selects the independent contractor
- Send the independent contractor the PAFA Independent Contractor template consulting agreement with the scope of work and deliverables sections completed.
- Instruct the independent contractor to 1) complete name and address; 2) confirm the scope of work and deliverable; 3) sign, and 4) return the agreement with completed W-9 to the hiring manager.
- Forward the completed agreement (item 4 above) to HR and finance with the email information for the independent contractor so that HR and finance can follow up when needed.
Human Resources: Makes the determination regarding employee versus independent contractor status – see step 1 under hiring manager will make the final determination of an individual’s relationship with PAFA. The assessment of the work characteristics will conclude with one of the following results:
- Result 1: Employee – If the supervisor or the department expect to assert employer controls, the individual is to be engaged as an employee and paid according to the provisions for employees. For nonresidents, the individual’s visa must qualify for employment in the determination of eligibility to work.
- Result 2: Independent Contractor – If the work will be free from employer controls, the individual may be engaged as a contractor and paid according to the provisions for engaging independent contractors.
- Result 3: Unclear – If the result of the assessment is unclear, the individual will be hired and paid as an employee to ensure tax compliance.
- If an employer-employee relationship would be established, the department shall follow the normal employment process.
Finance: The Finance team will complete the following actions.
- Reviews the completed agreement for payment options.
- Contacts independent contractor regarding payment options, if necessary.
- Files signed agreement.
- Processes approved invoices for payment.
- Prepares annual 1099.