IRS Clarifies “Employee” Versus “Independent Contractor” Test

The IRS recently issued clarifying guidelines to help employers determine which workers should be treated as independent contractors or employees. The government naturally wants accurate decisions to be made since they determine when it’s paid certain taxes on each worker’s wages.

The main deductions that should be subtracted from all employees’ paychecks include those for Social Security, Medicare, unemployment and income taxes. When a business has work done by an independent contractor, that person must pay all those taxes in the form of self-employment tax.

What remains the general standard for deciding if a worker is an independent contractor?

If an employer reserves the right to only direct control over the result of the work – and cannot tell a worker exactly what to do and how to handle the assignment – then that worker will usually be legally viewed as an independent contractor.

However, deciding what constitutes specific directions for completing a given task can still fall into a gray area.

Fortunately, there are three basic analytic categories that can help employers accurately determine when workers are properly classified as “employees” or “independent contractors.”

What are the three main categories of analysis for deciding a worker’s correct status?

The IRS indicates that employers should carefully examine the following three aspects of how they relate to workers to determine their proper work status.

  1. Behavior control. An employer may have behavior control over a worker even when it does not exercise it. For example, when such control is involved, it may include telling a worker which specific tools to use and where those supplies should be purchased. Under those circumstances, the worker should be considered an employee. Conversely, the less control over a worker’s behavior, the greater the chance that the person is working as an independent contractor.

If there are strict guidelines for determining the quality of the work provided, there’s a strong chance that the worker is an employee. When the worker is provided a bit more leeway in terms of quality control – there’s a stronger chance that the person is an independent contractor.

Of course, the two parties will usually need to agree to some basic quality standards, regardless of whether the worker is an employee or independent contractor. Finally, if periodic training or ongoing training is required of a worker – that increases the chances that the worker should be treated as an employee.

  1. Financial control. Does the worker have to personally cover the majority (or all) of the expenses tied to completing the work? These might include the purchase and maintenance of proper computers, printers, fax machines, scanners and other required equipment. If the worker is covering all those expenses, he or she should probably be classified as an independent contractor.

Stated differently, when a worker has many unreimbursed expenses, that person is usually an independent contractor — not an employee. Independent contractors are also those who retain the right to continue obtaining additional work from other parties. As for the payment for services, independent contractors are usually paid a flat fee – although that arrangement can vary in some cases.

  1. How the employer and worker each perceive the nature of their relationship. When the parties have not negotiated any employee benefits like vacation pay, sick pay, a pension plan and stock options – the worker is usually an independent contractor. While a written contract signed by the two parties can indicate how they view their interactions, it’s not always the only evidence the IRS and the courts will review when classifying the work relationship. All relevant documents and communications may need to be examined.

The main consequence for an employer who misclassifies a worker is that the employer may be required to pay all employment taxes currently owing for that worker – as opposed to requiring the worker to cover them.

What unique emphasis is placed on these three categories in the updated guidelines?

As for behavior control, employers really shouldn’t be telling the independent contractor the exact sequence of events for all tasks to be performed or exactly how they should be handled.

Regarding financial control, only independent contractors can experience a profit or loss while handling assigned tasks. Employees whose expenses are generally covered will usually not experience any profit or loss while completing assigned tasks on a given schedule.

As for how the parties view their work relationship, a fully executed contract can be controlling when other conclusive details aren’t available. However, as briefly noted above, the parties’ communications can usually provide clear indications of whether they’re interacting as employer-employee or employer and independent contractor.

The key bottom line for employers who don’t want to only work with employees – is to allow their independent contractors considerable flexibility while completing tasks – while respecting professional standards acceptable to both parties.

Please give our law firm a call if you need any help determining which workers are employees or independent contractors. We can also help you better understand the many different types of classifications that govern a wide range of employees you may want to hire – and the tax consequences for hiring those who fit in each group.

Our firm always remains available to help you draft many different types of contracts that can serve all your business needs.

How Wage Garnishment Laws Affect Many Texans

Although wealthier Texans may build up significant savings and retirement accounts by middle age, most residents must keep working far longer to meet their individual and family needs. And if unexpected family or medical crises occur creating new financial emergencies, some people may face wage garnishments. Fortunately, Texas offers strong protection against many types of creditors.

Here’s a brief review of the most common types of wage garnishments pursued in Texas, basic terms you’ll need to know regarding this field – and references to special concerns you may need to discuss with your Houston business law attorney to fully protect your rights.

Important terminology related to attaching employee wages

  • Wage garnishments. In Texas, this term is often used interchangeably with “wage attachments” and refers to court orders directing employers to withhold certain amounts of money from employee paychecks to satisfy certain debts;
  • Administrative garnishments. These usually refer to federal government back taxes or student loans now in default – and they do not require a court order to be activated. Once debtors have student loans in default, they’ll normally be contacted by the U. S. Department of Education and told which collection agencies will be collecting their debts. (Note: Students loans can almost never be discharged by a bankruptcy filing);
  • Disposable earnings. This refers to the amount of money you have left in your paycheck after all mandatory deductions have been made for federal taxes, disability insurance, union dues, unemployment insurance, nondiscretionary retirement deductions, workers compensation and health insurance.

Types of debts often leading to wage garnishment

Texans are very fortunate compared to citizens of other states since Texas only honors a very limited number of garnishable debts.

  1. Unpaid child support and alimony (in arrears)
  2. Current court-ordered child support and alimony
  3. Government debts owed to the IRS (back taxes) — and all related fines and penalties
  4. Unpaid student loans (in arrears)

Note:  In light of Article IV of the U. S. Constitution, Section I (requiring each state to honor the “public acts . . .  and judicial proceedings of every other state,” certain other limited creditor debts referenced in judgments obtained outside of Texas may also be garnishable.

Be sure to speak with your Houston business law attorney whenever you receive any notice of an order to garnish your wages.

Fixed garnishment limitations that benefit Texas debtors

  • Total amount that can be garnished (based on all court orders). This is equal to 50% of your disposable earnings;
  • Percentage allowed for tax debt. This varies, based on your current deduction rate, the number of your dependents and other factors;
  • Student loans. The Department of Education can normally only garnish up to 15% of your disposable income from each paycheck;
  • Spousal support. The most your wages can be attached for this obligation is either $5,000 or 20% of your average monthly gross income – whichever is less.

Priority of wage garnishment orders

Although unusual factors might be able to change the list below, employers must normally prioritize their payment of garnishment orders in the following manner.

  • Unpaid child-support
  • Spousal support
  • Back taxes
  • Student loans

Texas employers are not allowed to discriminate against employees with wage garnishments

This has long been a concern of many employees since handling wage garnishments can take up a considerable amount of an employer’s time. Texas doesn’t allow those with wage attachments to be treated unfairly when it comes to hiring, promoting, demoting, reprimanding and firing (among other actions).

How creditors can still reach your money – apart from using wage garnishment

Even if your wages cannot be reached, regular creditors can still gain access to your money by obtaining court orders to freeze one or more of your financial accounts – and place liens on certain types of real property you own.

Please contact our law firm with any questions you may have about the proper handling of court orders to garnish wages — or any other types of administrate tasks regarding employees.

Does the Issuance of a 1099-C Discharge Debtors from Liability?

Does the issuance of a 1099-C discharge debtors from liability? The answer is no, the issuance of a 1099–C does not discharge debtors from liability from the subject debt. The filing of a Form 1099–C is a creditor’s required means of satisfying a reporting obligation to the IRS; it is not a means of accomplishing an actual discharge of debt, nor is it required only where an actual discharge has already occurred.

The fact situation is simple and straightforward. A creditor who has loaned money to a debtor makes an internal decision to “write off” of the debt on its books. At that point in time, the creditor is required by IRS regulations to report the write-off.

While only a handful of courts across the United States have addressed this issue, most have arisen in the context of a bankruptcy. Almost every court that has addressed the issue and the few reported decisions in Texas have concluded that the issuance of a 1099–C does not discharge debtors from liability of the subject debt.

The most thorough analysis of the issue and most cited opinion is In re Zilka, 407 B.R. 684 (Bankr. W.D. Pa. 2009), a bankruptcy decision from Pennsylvania. The Court in In re Zilka found four separate independent legal basis upon which to hold that the issuance of a 1099–C does not discharge debtors from liability. The four legal bases are as follow:

1. The IRS requires the issuance of a 1099-C. 26 U.S.C. § 6050P(a) provides, in pertinent part, that “[a]ny applicable entity which discharges . . . the indebtedness of any person during any calendar year shall make a return . . . setting forth . . . the name, address, and TIN of each person whose indebtedness was discharged . . .  [as well as] the date of the discharge and the amount of the indebtedness discharged.” The information return just referred to is a Form 1099–C.

However, “a discharge of indebtedness” is “deemed to have occurred . . . if and only if there has [been] an identifiable event described in paragraph (b)(2) of this section, whether or not an actual discharge of indebtedness has occurred on or before the date on which the identifiable event has occurred.” 26 C.F.R. § 1.6050P–1(b)(2) sets forth eight identifiable events that can trigger the filing and issuance of a Form 1099–C, among which is “(G) [a] discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt.”

2. The IRS does not view a Form 1099–C as an admission by the creditor that it has discharged the debt and can no longer pursue collection. In an IRS Information Letter issued in October 2005 it addressed concerns regarding the impact of a creditor’s compliance with the Form 1099–C reporting obligation and the continuing liability of a debtor on the subject debt. The IRS assured a concerned creditor that filing a Form 1099–C satisfies the reporting requirements of the statute and implementing regulations, neither of which “prohibit collection activity after a creditor reports by filing a Form 1099–C.”

3. That a Form 1099–C does not constitute an admission by the creditor that it has discharged the debt and can no longer pursue collection thereon is consistent with the fact a creditor can issue a corrected Form 1099-C if a recovery of some or all of the monies owed by the debtor subsequently occurs. In another IRS Information Letter issued in October 2005, the IRS responded to a creditor that it “does not view a Form 1099–C as an admission by the creditor that it has discharged the debt and can no longer pursue collection.”

4. The issuance of a Form 1099–C does not constitute one of the means of discharging debt pursuant to the Uniform Commercial Code, § 3.604 governs Negotiable Instruments. Section 3.604 of the Tex. Bus. & Comm. Code, Discharge by Cancellation or Renunciation provides that:

• A person entitled to enforce an instrument, with or without consideration, may discharge the obligation of a party to pay the instrument:

(1) by an intentional voluntary act, such as surrender of the instrument to the party, destruction, mutilation, or cancellation of the instrument, cancellation or striking out of the party’s signature, or the addition of words to the instrument indicating discharge; or

(2) by agreeing not to sue or otherwise renouncing rights against the party by a signed record.

The most recent Texas court to address the issue was Capital One, N.A. v. Massey, No. 4:10 CV–01707, 2011 WL 3299934 (S.D. Texas Aug. 1, 2011) wherein the United States District Court for the Southern District of Texas “adopt[ed] the view that a 1099–C does not discharge debtors from liability” because the form is “issued to comply with IRS reporting requirements” and the IRS does not view it “as a legal admission that a debtor is absolved from liability for a debt.”

Lasting, pursuing collection of a debt that has been written off and reported on a 1099-C does not violate Tex. Fin. Code § 392.304(a)(8) which prohibits the collection a debt that was “discharged and/or extinguished against them.”