An advisor asked, “Who is considered an ‘independent contractor,’ and should he or she be included in the retirement plan of the employer who contracts for his or her services?”
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor from Massachusetts is representative of a common inquiry involving independent contractors and retirement plan eligibility.
Highlights of the Discussion
- This is a very timely question because the Department of Labor (DOL) has gone back and forth regarding its final definition of independent contractor in 2020 and 2021. Because determining the correct worker status is an important tax question it is advisable to seek the help of a qualified tax professional. What follows is a general explanation of the DOL’s independent contractor rules for educational purposes only as they stand to date.
- First, a little background. Historically, the industry has looked to the Fair Labor Standards Act of 1938 (FLSA), court rulings and informal guidance from the DOL and IRS to help define who is an independent contractor (and not an employee).
- The U.S. Supreme Court on several occasions has ruled that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation that controls. Among the factors which the Court has considered significant are
- The extent to which the services rendered are an integral part of the principal’s business.
- The permanency of the relationship.
- The amount of the alleged contractor’s investment in facilities and equipment.
- The nature and degree of control by the principal.
- The alleged contractor’s opportunities for profit and loss.
- The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
- The degree of independent business organization and operation.
- In September 2020, during the Trump administration, the DOL issued proposed regulations that would have provided an “economic reality” test to determine a worker’s status as an independent contractor. On January 6, 2021, the DOL issued a final rule clarifying the standard for employee versus independent contractor based on the economic reality test. The effective date of the final rule was March 8, 2021. However, on February 5, 2021, at the start of the Biden administration, the DOL published a proposal to delay the independent contractor rule’s effective date until May 7, 2021. On March 4, 2021, after considering approximately 1,500 comments received in response to that proposal, the DOL published a final rule delaying the effective date of the independent contractor rule to May 7, 2021. Then, on May 5, 2021, after reviewing approximately 1,000 comments it received, the DOL withdrew the independent contractor final rule. The end result—the DOL’s most recent independent contractor rule never took effect.
- Consequently, it is “back to the future;” the DOL’s longstanding prior guidance addressing the distinction between employees and independent contractors under the FLSA remains in effect (see Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).
- The IRS has some helpful online information as well on determining worker status at Independent Contractor (Self-Employed) or Employee?
- In a nutshell, the determination of whether a person who provides services to a business is considered an employee or independent contractor is based on the degree of “control or direction” provided by the business to the worker and is dependent upon the facts and circumstances of each case. Generally, an individual is an independent contractor if the business for which he/she performs services, does not control the means or methods used by the worker to accomplish the promised result. It is important for the business owner to look at the entire relationship with the worker, consider the degree of his or her right to direct and control the worker’s actions and, finally, to document each of the factors the business owner uses to arrive at the determination.
- As an alternative, a person or entity can ask the IRS to make a formal determination on a worker’s status by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The filing takes at least six months to process.
- With respect to retirement plan participation, a person who meets the definition of an independent contractor is not an employee of the business for which he or she provides services and, therefore, would not be eligible to participate in the business’s retirement plan.
- However, an independent contractor could contribute to his or her own retirement plan based on his or her self-employment income.
Determining whether a worker is an employee or independent contractor for tax purposes as well as retirement plan coverage purposes can be tricky. In 2020 and 2021, the DOL floated regulations which were later withdrawn, that included an “economic reality” test, to determine a worker’s status. The DOL’s longstanding prior guidance addressing the distinction between employees and independent contractors under the FLSA remains in effect Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).