Independent Contractor Guidelines

Employee: The IRS and the courts define the term employee for purposes of these withholding requirements as any individual whose employment status meets the common law requirements for an employer-employee relationship.

Independent Contractor: An independent contractor relationship exists when the University has the right to control only the result of the service, not the manner of performance.

Independent Consultant: Independent consultants are a kind of independent contractor. An independent consultant relationship exists when the University does not control either the result of the service or the manner of performance. An independent consultant is not employed by the University and is typically a person of professional or technical competence who provides advice to the University. 

As a general rule, the IRS leans toward classifying University Extension instructors as employees rather than as independent contractors. However, whether an individual should be paid as an employee or as an independent contractor depends on the applicable facts and circumstances. Extension courses and programs should be hired as employees or retained as independent contractors. The guidelines apply to the following:

• Course or program instructors hired for short and long duration;
• Guest lecturers; and
• Panelists or workshop participants.

An Independent Contractor Packet is not required to be completed for individuals retained to provide temporary services as instructors of short duration (e.g., not to exceed twelve (12) calendar days in one calendar year), guest lecturers, and panelists or workshop participants. However, an Independent Contractor Packet must be completed for an instructor who is retained to teach a course of longer duration.

University administrators should use the following basic guidelines to help determine whether an individual who will provide services of a temporary nature to University Extension should be hired as an employee or retained as an independent contractor:

1. University faculty and other academic appointees who provide teaching services to University Extension must be paid as employees regardless of the length of the course or program (Academic Personnel Manual 663). University employees who do not have academic appointments also must be paid for University Extension teaching services as employees per the Policy Regarding Employee-Vendor Relationships.
2. Except as provided below, an instructor or other person who is in charge of a University Extension course or program must be hired as a University employee. This classification applies whether or not credit is associated with the course or program.
3. Individuals who are not University employees should be treated as independent contractors if they:
   
   1. are to participate as a guest lecturer on one or more occasions in a University Extension course or program,
   2. are to participate on one or more occasions as a panelist or workshop participant in a University Extension course or program,
   3. are a panelist for a University Extension course or program that consists exclusively of one or more panel discussions, and
   4. are retained as an instructor retained to teach a course or courses of short duration, provided that the total number of days that the person teaches does not exceed 12 calendar days in one calendar year. Each day devoted to teaching would count as one calendar day regardless of the number of teaching hours worked in any of those days.
4. An instructor who is retained to teach a course that exceeds 12 days must be hired as an employee unless he or she is either (i) a bona fide employee of a company or organization that provides similar teaching services to others, or (ii) operates an independent business that provides similar teaching services to others. The following factors support independent contractor status:
   
   1. The individual will be providing more than de minimis services to other clients during the University engagement;
   2. The individual appears to be operating a bona fide business (the individual is incorporated, has a taxpayer identification number, a business license, business letterhead, a separate business location, etc.);
   3. The individual receives a flat fee for services performed vs. payment on an hourly basis;
   4. The individual advertises his or her services to the larger community. 

UC Independent Contractor Guidelines for Federal Tax Purposes contains additional criteria that bear on whether a University Extension instructor should be classified as an employee or an independent contractor.

University policy (Business and Finance Bulletin BUS-63, Insurance Requirements and Certificates of Insurance) requires that individuals retained as independent contractors show evidence of adequate insurance coverage. Locations should contact the respective Risk Manager to determine appropriate levels of coverage for such individuals.

Questions concerning this policy should be directed to the Associate Vice President Systemwide Controller.

It is important to determine the correct classification of workers as employees or independent contractors. This distinction is significant because an incorrect determination could result in the following:

• Loss of reimbursement under federal contract and grant funds;
• Penalties for violation of State and federal tax withholding laws (see Section VIII.F., IRS Penalties, below);
• Penalties for violation of federal laws about the employment of aliens (Form I-9).

In addition, the following employment-related requirements may be violated:

• State Oath of Allegiance, as required by the California Constitution;
• State Political Reform Act, financial conflict of interest rules.

Background

Under the Internal Revenue Code, employers are required to withhold income and FICA taxes on wages paid to employees. The IRS and the courts define the term employee for purposes of these withholding requirements as any individual whose employment status meets the common law requirements for an employer-employee relationship.

Generally, under common law, if an employer has the right to direct and control the work of an individual who performs the services, not only as to the results to be accomplished but also as to the methods and means by which the results are accomplished, an employer-employee relationship exists. In this respect, even if the employer does not exercise the right to direct or control the manner in which the worker performs the services, the fact that the employer retains the right to do so is sufficient.

On the other hand, if the individual is subject to the direction or control of another person only as to the end result, not as to the methods and means used to accomplish that result, the individual is not an employee. If the employer does not control either the manner of performance or the result of the service, the individual is not an employee and an independent consultant relationship exists.

IRS Employee Classification Factors

The factors that the IRS takes into account in making employee/independent contractor determinations are set forth in a 1996 internal IRS training manual. The training manual focuses on the common law “direction and control” test as the primary test in making employee/independent contractor determinations and focuses on three areas that must be examined in making such determinations -- evidence showing behavioral control, evidence showing financial control, and evidence demonstrating the relationship between the parties.

Behavioral control primarily involves training and providing instructions to the worker. The training manual includes a detailed description of the different types of instruction that can constitute appropriate evidence that behavior-related direction and control are present. For example, if a worker is instructed to obtain approval before taking certain actions, he or she is likely to be classified as an employee. However, the manual distinguishes between instruction as to what is to be done and instruction as to how it is to be done, with only the latter type of instruction reflecting employee situations. For example, assume that an independent truck driver receives a call from a manufacturing company to make a delivery in a certain part of the United States. When he picks up the cargo for delivery, the company gives him an address at which the cargo should be delivered and tells him that the delivery must be completed within two days. This is an instruction as to what is to be done, rather than how it is to be done and is consistent with independent contractor status.

Financial control over the worker relates to the business aspects of the relationship, and the question to be asked is: “Does the recipient have the right to direct and control business-related means and details of the worker’s performance?” Evidentiary aspects that are important include whether the worker

1. has made a significant financial investment in the business activity (indication of independent contractor);
2. receives reimbursement for the business expenses incurred (indication of employee);
3. provides the same or similar services to other members
   of the general public (indication of independent contractor);
4. receives a salary, flat fee, or commission (salary indicates employee; flat fee/commission indicates independent contractor); and
5. has the opportunity for personal profit or loss from the activity (indicates independent contractor).

The final category of direction and control evidence -- the relationship between the parties -- relates to how the two parties perceive their own relationship and includes such items as whether

1. the employee receives employee-type benefits, such as vacation days, sick days, and health insurance;
2. a written contract exists and sets forth the worker’s duties and the terms and conditions of the contract;
3. the relationship is expected to be a permanent one;
4. the worker can be discharged at any time without incurring a penalty; and
5. the worker’s activities are part of the regular business activities of the employer.
6. The training manual also sets forth various less-important factors used in making worker classifications, including whether the individual works part-time or full-time, whether the employment is temporary, the location where the worker conducts his or her activities, and the hours that the individual is required to work.

Dual Status Workers

The IRS recognizes that an individual may perform services for a single business in two or more separate capacities. A dual-status worker performs one type of service for a business as an independent contractor but performs a different type of service for the business as an employee. Such services must be separate and distinct, (e.g. there can be no interrelation either as to duties or remuneration in the two capacities).

Even though the IRS has in some cases recognized that an individual can be properly classified as both an employee and an independent contractor – and the 1996 training manual recognizes that such a dual worker status may exist – the IRS reviews these situations quite closely. Therefore, if an individual receives a Form W2, Wage and Tax Statement, from a college or university, the IRS normally will assume that all income paid to the individual by the college or university is earned as an employee, and it will be up to the school to demonstrate to the contrary. And, as a general rule, if an individual conducts teaching services in an employee capacity, all other teaching activities will likewise be treated as employee services. For example, if a full-time professor teaches an out-of-town seminar, the IRS normally will assert that the income should be reported on a W-2 along with his or her regular
faculty salary. The IRS also takes the position that if two individuals have the same job description (e.g., both are professors), but one works full-time and one works part-time, both should be considered employees.

On the other hand, if you can clearly show that the employee’s independent contractor work is unrelated to his or her compensation or evaluation as an employee, the IRS should permit dual worker classification. Certain types of payments received by employees are reportable on a Form 1099 (e.g., damage payments, royalties, rental payments, or payments for bona fide independent contractor services)

If an employer treats services performed by an employee as though they were performed by a non-employee, the IRS penalty assessments against the employer could include the following:

1. Penalty for Improper Classification (I.R.C. Section 3509, Determination of Employer's Liability for Certain Employment Taxes)
   The general rule is that the employer is liable for all the taxes the employer would have owed and all the taxes the employer should have withheld from the employee and paid to the government. However, Section 3509 provides for less severe consequences:
   The rate for failure to withhold income tax is 1.5% of the wages, doubled to 3% if the employer failed to file Form 1099 for the misclassified independent contractor;
   The employer remains liable for its share of FICA and for 20% of the employee’s unpaid FICA taxes, double to 40% if the employer fails to issue Form 1099.
2. Penalty for Failure to File Returns (I.R.C. Section 6651(a)(1), Failure to File Tax Return or to Pay Tax)
   A 5% penalty for failure to file applies when an employer fails to file a return on the due date and there is a tax due. The penalty is based on the amount required to be shown on the return minus any part of the tax that was paid on or before the due date. Another 5% penalty is charged for each additional month, or fraction thereof, during which the failure continues; however, the penalty may not exceed 25% in the aggregate.
3. Penalty for Willful Failure to Collect Tax
   A penalty, equal to 100% of what the contractor should have paid in taxes, for an employer's willful failure to withhold from a non-corporate independent contractor's pay, if the contractor failed to pay income taxes.

The safe harbor rules of Section 530 of the Revenue Act of 1978 (and subsequent modifications) provide employers with relief from the taxes and penalties detailed in Sections VI., Misclassification of Workers and VII.F., IRS Penalties, above. Under these rules, an individual will be deemed not to be an
employee for purposes of income and employment taxes if all three of the following conditions are met:

1. The employer had a reasonable basis for treating the worker as an independent contractor;
2. The employer treated workers performing similar services as independent contractors; and
3. All Federal tax returns filed by the employer have consistently treated the independent contractor and all workers in similar positions as independent contractors.

An employer has a reasonable basis for not treating a worker as an employee if it relies on any of the following:

1. Judicial precedent, published rulings, technical advice or a letter ruling issued to the employer;
2. A past IRS audit of the employer in which the IRS did not assess employment tax deficiencies for amounts paid to individuals holding positions substantially similar to the position held by the worker whose status is being questioned4; or
3. Long-standing recognized practice of a significant segment of the industry in which the worker is engaged, i.e., 25% or more of an industry for 10 years.

Applicability of Section 530 to the University
Due to the fact that there are conflicting rulings regarding the applicability of Section 530 to government agencies and instrumentalities, there is some uncertainty as to whether Section 530 relief is available to a governmental entity such as the University.

It is the responsibility of the originating office to determine the correct status of workers in coordination with the appropriate local office (e.g. Human Resources, Campus Counsel, and Purchasing) as needed. In order to ensure that individuals performing services for the University are properly classified, the Independent Contractor Packet, which is based on the foregoing IRS classification factors, should be completed prior to hiring a worker as an independent contractor. 

In general, the determination regarding employee versus independent contractor status is made by each location according to local policy. However, in cases where it is difficult to determine a worker's correct status the Human Resources Department or the Office of the President Payroll Coordination and Tax Services Office, in coordination with the Office of General Counsel, can provide assistance in determining whether an employer-employee relationship exists.

It is the responsibility of the campus payroll office/UC Path to comply with the procedures for Federal income tax withholding and reporting, as specified in these Guidelines. The Office of the Executive Vice President-Chief Financial Officer is responsible for all updates to these Guidelines.