An overview of whether workers should be classified as employees or independent contractors, according to IRS rules can be found below. This is a complicated issue that can lead to long-term tax problems for both workers and employers, so it is critical to understand the IRS's definitive take on the issue.

The distinction between an employee and an independent contractor is governed by both federal law and state law. Because of the significant payroll tax revenues involved, the states are the most aggressive in classifying workers as employees. The first part of this chapter covers the federal issues and the second part covers classification under California Assembly Bills AB 5, 2257, 1506 and 1561. California preparers and preparers in states that use the ABC test may wish to skip to the California section.

Frequently, the Internal Revenue Service and taxpayers disagree about the classification of workers as independent contractors or employees. At stake is the collection of employment taxes, as well as eligibility to participate in the employer’s retirement plan. The IRS has developed audit programs that focus on employers who “misclassify” workers as independent contractors. These IRS programs can be expensive for employers and particularly painful for small businesses that may not be able to withstand the “economic strain” of additional employment taxes. And a worker who was misclassified as an independent contractor could also put the business’s retirement and benefit plans in jeopardy for failing to cover all employees. This chapter contains guidelines that can be used to help determine the status of workers--whether independent or employee.