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Guest Article

Deloitte logo

(From the September 8, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS PLR Illustrates Factors Used to Determine If a Worker Is an Employee Subject to Federal Employment Taxes


Relying on the factors enumerated in Treasury Regulations, IRS has issued a private letter ruling illustrating the application of three key categories -- behavioral control, financial control and the parties' relationship -- in determining whether a worker is an employee subject to FICA, FUTA and income tax withholding. Private Letter Ruling 200835025, Issued May 21, 2008 (Released August 29, 2008).

The Work Arrangement

An individual worked as a medical technologist, performing clinical laboratory testing for a federal agency which provided health care in a hospital setting. He performed the work as an independent contractor pursuant to successive "service orders," although he had been previously retained by that agency to perform those services as an employee.

The agency provided the individual with an orientation to each laboratory department in which he was expected to work, and also administered a competency assessment. The individual worked under the management of an agency supervisor, who assigned him to a specific laboratory each day. He followed the procedures outlined in the department's procedural manual and was required to attend staff meetings. The individual performed all the services himself and did not hire others to assist. He did not perform similar services for others and did not advertise his services. The agency provided all of the equipment and supplies, and the individual incurred no expenses in performing the work. He did not receive any benefits from the agency, but was required to record his time on a sign-in sheet and submit an invoice to the agency for payment. The individual was paid at an hourly rate. Both parties agree that the individual performed the same services as he had previously performed as an employee.

IRS Analysis

A ruling was requested from IRS regarding whether the payments made by the agency to the individual for the services he performed were subject to federal employment taxes -- i.e., the taxes imposed by the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA) and the federal income tax withholding requirements.

In its ruling, IRS cited the provisions of Internal Revenue Code § 3121(d) -- which generally defines "employee" for purposes of FICA and FUTA -- as "any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee." Whether an individual is a common-law employee depends on the particular facts of each case. However, the Treasury Regulations under IRC § 3121(d) -- which are substantially similar to those under IRC § 3401(c) regarding income tax withholding -- provide generally that:

... the relationship of employer-employee exists when the person for whom the services are performed has the right to direct and control the individual who performs the services not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. It is not necessary that the employer actually direct or control the manner in which the services are performed, it is sufficient if he or she has the right to do so.

If an employer-employee relationship exists under the facts, the designation given by the parties is immaterial. That is, the true nature of the relationship is determinative and not how the parties choose to designate it (e.g., as a partner, independent contractor, agent, etc.).

The ruling explains that the relevant facts typically fall in to three categories:

  1. Behavioral Control -- whether the service recipient has a right to direct or control how the worker performs the specific tasks for which he is hired (e.g., whether training or instruction is given).
  2. Financial Control -- whether the service recipient has a right to direct or control the financial aspects of the worker's activities (e.g., whether the worker has made a significant investment, has un-reimbursed expenses, or makes services available to the market).
  3. Relationship of the Parties -- the relationship as evidenced by the parties' agreements and actions with respect to each other, including facts which show not only how they perceive their relationship but also how they represent their relationship to others (e.g., the intent of the parties as expressed in written contracts, the provision or lack of employee benefits, the right to terminate the relationship, the permanency of the relationship, and whether services performed are part of the service recipient's regular business activities).

Based on the facts, IRS concluded that the services performed by the individual were sufficiently subject to the "direction and control" of the agency to establish an employer-employee relationship. IRS noted that the agency gave instructions and training, generally established the manner in which the individual performed his work, and provided all supplies and equipment. It noted that the individual did not have a significant investment or opportunity for loss or profit. The absence of employee benefits and language in the service orders indicated an attempt to establish an independent contractor relationship -- however, the weight of the evidence indicated that there was a level of control sufficient to establish an employer-employee relationship.

As a result, amounts paid to the individual for the services he performed while designated as an "independent contractor" actually constituted wages subject to FICA, FUTA and income tax withholding.

Lessons to Take Away

A private letter ruling may be relied upon only by the taxpayer to whom it is addressed. However, PLRs provide a worthwhile illustration of how the IRS applies the law to a particular set of facts. This PLR reaffirms the general rule that the facts -- rather than the designation given by the parties -- will govern whether an individual is an employee for purposes of federal employment taxes, and reaffirms that the overarching issue is whether the service recipient (i.e., the putative employer) has the right to direct or control the manner in which the work is performed. Failure to timely submit FICA, FUTA and income tax withholding amounts can potentially subject the employer to penalties and interest for the late payment. Although IRS will not issue a ruling on all matters, whether an employer-employee relationship exists is a matter on which a private letter ruling may be requested.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.


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