Worker Status Key for Correct Withholding, Penalty Avoidance

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Employers should be careful to appropriately classify workers under various federal and state laws to avoid substantial penalties and to ensure that workers have access to benefits and protections to which they are entitled.

Wisconsin became the latest state to sign a memorandum of understanding with the Labor Department on Jan. 20, joining 19 other states that have agreed to share information and coordinate law-enforcement efforts to reduce misclassification of employees as independent contractors or other nonemployee statuses. Florida signed a memorandum Jan. 13, the department said.

The department is seeking memorandums of understanding with additional states, the department said on its website.

In 2013, the department's Wage and Hour Division collected more than $83 million in back wages for misclassified workers, a division news release said.

Employee Tests Can Vary

The government and courts use several methods to determine whether a worker is an employee or an independent contractor.

Under common law, a worker who performs services is an employee if the employer has the right to control what will be done and how it will be done, even when the worker has the freedom of action in accomplishing the task. The key point is that the employer has the right to control the details needed to carry out the job.

The worker's title does not matter, even if the worker is a part-time employee. As long as the employer is entitled to control what services are required and how the duties are carried out, the individual worker must be treated as an employee for tax withholding purposes.

The description or designation that the parties give to their relationship generally is irrelevant to classification, regardless whether the individual is called a partner, employee, agent or independent contractor.

To determine whether a worker is an employee or an independent contractor under common law, consideration must be given to the degree of control and the degree of independence provided to the worker. 

The three factors governing common-law consideration are behavioral control, such as where, when and how to do the work; financial control, including the worker's ability to realize a profit or loss; and the type of relationship, which can be described in a written contract.

To be considered an independent contractor, workers must meet three criteria:

•The worker is free from control or direction in performing the work.

•The work is done outside the usual course of the employer's business and is done off the premises.

•The worker is usually engaged in an independent trade, occupation, profession or business.

Federal and state courts also have relied on versions of the economic reality test to establish whether a worker is an employee or an independent contractor.

Some or all of these factors are used by courts to determine worker status, including:

•the degree that the employer controls or directs the manner in which work is performed,

•whether the worker's opportunity for profit or loss depends on his or her managerial skills,

•whether the worker's duties are performed for the employer on an ongoing or permanent basis,

•whether the service performed by the worker is an integral part of the employer's business,

•the extent of the worker's investment in equipment or materials needed to perform the job and

•the degree that worker is engaged primarily for the employer's benefit.

While many state tax, unemployment insurance and labor laws generally follow federal common law guidelines for worker status, there can be variations within those laws.

Statutory Employees


Under the Internal Revenue Code, there are two categories of workers exempt from federal income tax withholding: statutory employees and statutory nonemployees. Statutory employees are covered by the Federal Insurance Contributions Act and Federal Unemployment Contributions Act; statutory nonemployees are exempt from income withholding, FICA withholding and FUTA coverage.

Statutory employees are those in occupational categories subject to FICA or FUTA coverage, even though they might qualify as independent contractors exempt from income tax withholding under the common-law test. The statutory employee categories include traveling or city sales representatives, agent drivers and commission drivers, life insurance salespersons and home workers.

Statutory nonemployees are qualified real estate agents and direct sellers. Such workers are considered self-employed for federal income tax withholding, FICA and FUTA if substantially all compensation is related to sales output and services are rendered under the terms of a written contract specifying that they are not employees for federal tax purposes.

For more information, see PAG's “Employee/Employment Coverage Rules: FITW, FICA and FUTA”  chapter.

To contact the reporter responsible for this story: Allison M. Gatrone at

To contact the editor on this story: Michael Trimarchi at