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independent contractors

An independent contractor (also known as a freelancer) is a person or entity who agrees to work for another person or entity as a nonemployee. Because of the independent contractor’s status as a nonemployee, the contractor must pay their own Social Security and Medicare (FICA) taxes. And the person or entity hiring the independent contractor has no obligation to withhold income taxes from the contractor’s fees. It is important for the person or entity who hires a worker to properly classify the worker as an employee or as an independent contractor based on the IRS’s right-to-control test.

In Texas, the classification of a worker as an independent contractor or an employee is significant for tax purposes and compliance with labor laws. Independent contractors, unlike employees, are responsible for paying their own Social Security and Medicare taxes, known as self-employment taxes. The hiring entity does not withhold income taxes from payments to independent contractors. Proper classification hinges on the IRS's right-to-control test, which examines factors such as the degree of control the hiring party has over the way work is performed. If a worker is incorrectly classified as an independent contractor, the hiring entity may face penalties, back taxes, and interest. Texas adheres to federal guidelines for classification, and the Texas Workforce Commission also provides criteria to determine worker status for state employment laws. It is crucial for hiring entities to assess the relationship with the worker carefully, considering factors like behavioral control, financial control, and the relationship's nature, to ensure proper classification under both federal and state regulations.


Texas Statutes & Rules

Federal Statutes & Rules

Internal Revenue Code (IRC) Section 3121(d)(3)
This section of the IRC provides the definition of an employee for purposes of Social Security and Medicare taxes, which is relevant to distinguishing between an employee and an independent contractor.

IRC Section 3121(d)(3) defines an employee specifically for the purposes of FICA (Federal Insurance Contributions Act) taxes, which include Social Security and Medicare taxes. Under this section, an employee is generally someone who performs services under the control and direction of an employer, both as to what shall be done and how it shall be done. Conversely, an independent contractor is not subject to such control and direction and is therefore responsible for paying their own Social Security and Medicare taxes. The classification of a worker as an employee or independent contractor affects tax obligations, including who is responsible for withholding and paying these taxes.

Internal Revenue Code (IRC) Section 3401(c)
This section defines an employee for federal income tax withholding purposes, which is essential for understanding the tax obligations of the hiring entity.

IRC Section 3401(c) provides the definition of an employee for the purpose of federal income tax withholding. According to this section, an employee includes any individual who performs services if the relationship between the individual and the person for whom the services are performed is the legal relationship of employer and employee. Therefore, this definition is crucial for determining whether a hiring entity should withhold income taxes from payments made to a worker. If the worker is classified as an independent contractor, the hiring entity is not required to withhold income taxes from the contractor's fees.

Internal Revenue Code (IRC) Section 3509
This section outlines the liability for employers who incorrectly classify employees as independent contractors.

IRC Section 3509 addresses the consequences for an employer who fails to treat an individual as an employee for purposes of withholding and paying federal employment taxes. If the IRS determines that a worker who has been treated as an independent contractor is actually an employee, the employer may be liable for a percentage of the employee's wages for withholding purposes, as well as a percentage of the employee's FICA taxes. The rates of liability can vary depending on whether the employer had a reasonable basis for not treating the worker as an employee and whether the employer participated in the Voluntary Classification Settlement Program (VCSP).

Internal Revenue Code (IRC) Section 530 of the Revenue Act of 1978
This section provides relief to employers who have consistently treated workers as independent contractors under a reasonable basis.

IRC Section 530 of the Revenue Act of 1978 offers a safe harbor provision for employers who have misclassified employees as independent contractors. To qualify for relief under this provision, the employer must have had a reasonable basis for not treating the workers as employees, such as reliance on judicial precedent, published rulings, a past IRS audit, or a long-standing recognized practice of a significant segment of the industry. Additionally, the employer must have consistently treated the workers and similarly situated workers as independent contractors and must have filed all required federal tax returns consistent with the independent contractor classification, including Form 1099-MISC.

Internal Revenue Service (IRS) Common Law Test
The IRS uses a common law test, often referred to as the 'right-to-control test,' to determine worker classification for federal tax purposes.

The IRS Common Law Test, also known as the 'right-to-control test,' is used to determine whether a worker is an employee or an independent contractor for federal tax purposes. This test considers factors such as behavioral control (e.g., instructions, training), financial control (e.g., investment in equipment, opportunity for profit or loss), and the type of relationship (e.g., contracts, benefits). No single factor is decisive; instead, the IRS looks at the entire relationship and considers the degree of control and independence. Proper classification is critical as it affects the worker's eligibility for benefits and protections, and it determines the tax responsibilities of both the worker and the hiring entity.