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

Problems and Solutions

GGD-77-88: Published: Nov 21, 1977. Publicly Released: Nov 21, 1977.

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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.

Matter for Congressional Consideration

  1. Status: Closed

    Comments: Please call 202/512-6100 for additional information.

    Matter: Congress should amend the Internal Revenue Code to exclude separate business entities from the common law definition of employee in instances where they: have a separate set of records which reflect items of income and expenses, have the risk of loss and the opportunity of profit, have a principal place of business other than that furnished by the persons for whom he or she performs services, and are self-employed in their own home and/or make their services available to the public. If a worker cannot meet all of these criteria and there is evidence that he is self-employed, some type of common law criteria should be applied.

 

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