Taxable Scenarios Regarding Independent Contractors Overview

Independent contractors are subject to specific tax reporting and withholding rules that differ significantly from employees. Understanding these taxable scenarios ensures Indiana University remains compliant with federal regulations while also safeguarding against potential penalties for misreporting.

The standard below is focused on how to determine if a party should be classified as an employee or an independent contractor. Understanding this distinction is essential for fiscal officers because it determines how the university complies with external regulations, handles payments, issues tax forms, and manages risk. It establishes the criteria and expectations that must be applied when classifying an individual as an independent contractor versus an employee, and it prescribes the processes necessary to ensure compliance with applicable regulations.

The Office of the University Controller is in the process of converting Standard Operating Procedures (SOPs) into IU accounting standards. As such, this SOP is no longer being updated. Information is as current as of the date of last revision available on the SOP. Please continue to check back as SOPs are converted into standards within this book.

• TSOP 4.01 -Form W-9 Record Retention Requirements

UCO-Tax-7.00: Independent Contractor: Determination of Employee or Independent Contractor Status

Prerequisites

Prior to reading the standard on Independent Contractor: Determination of Employee or Independent Contractor Status, it is beneficial to review the below item to gain foundational information:

1. FIN-ACC-630: Independent Contractor versus Employee Status Determination

Preface

This standard discusses the requirements of an independent contractor as defined by the Internal Revenue Service (IRS) as well as the Department of Labor (DOL). Information presented below outlines the requirements and expectations of when an individual would be classified as an independent contractor versus an employee, as well as the relevant processes. Failure to follow these processes could result in potential fines and penalties as well as impact Indiana University’s ability to do business with independent contractors in the future. This standard does not govern independent contractor agreements that employees may have with external parties outside of Indiana University. Refer to UA-17 Conflicts of Interest and Commitment for agreements with external parties.

Introduction

What is an Independent Contractor?

In order to comply with the regulatory requirements of both the IRS and DOL, it is critical that fiscal officers and contracting units have a clear understanding of how these regulatory bodies define an independent contractor.

The DOL defines the term ‘independent contractor’ as a worker who, as a matter of economic reality, is not economically dependent on an employer for work and is in business for themselves.

The IRS generally defines an independent contractor arrangement as one where the payor has the right to control or direct only the result of the work and not the process of how the work will be completed.

Individuals compensated for services who do not meet the definitions of an independent contractor above are generally considered employees of the university.

The following examples are given to provide additional guidance regarding workers who might meet the criteria for independent contractor status:

• Guest performers or artists who otherwise are not affiliated with the university, whose engagement with the university is of short duration.
• Guest speakers who are brought to the university for a short duration because of their expertise in a given field of study.
• Individuals providing professional services such as attorneys, accountants, photographers, graphic designers, painters, landscapers, or other consultants who regularly provide these services to other clientele outside of the university.

For purposes of this standard and corresponding policy, Indiana University has specific required criteria for an individual providing services to the university to qualify as an independent contractor, as established in policy FIN-ACC-630: Independent Contractor versus Employee Status Determination

Importance and Impact of Independent Contractor

The following information summarizes some of the impacts that may arise if a fiscal officer or contracting unit does not properly determine the independent contractor or employee status.

Department of Labor

The Department of Labor (DOL) documents the most significant impacts of possible misclassification:

• be denied the right to minimum wages, overtime pay, and other protections.
• Tax burdens may be created for misclassified workers; governments may incur lost tax revenue.
• Unfair competition may be created for responsible companies that comply with the law.

Internal Revenue Service

The IRS has a process for potentially misclassified independent contractors to make a claim against the payor.

• Through this process, the payee may reclaim taxes on wages they believe should have been paid by the employer.
• These processes correspond with thorough investigations from regulating bodies, which can become costly and time-consuming on an internal level for contracting units and units such as UCO Tax, General Counsel, Internal Audit, and others. If Indiana University is found to be at fault for having applied an incorrect payment method determination, it could have extended consequences for both the university and the payees.

Additional consequences could include civil penalties for each misclassified payment which may result in additional expense and negative public consequences as a result of individual or class action lawsuits.

Misclassification of foreign individuals could have additional consequences in addition to those above both to the university and the individual.

Independent Contractor Discussed in Detail

Regulations and guidance related to independent contractors come from both the IRS and DOL. The fiscal officer (FO) is responsible for ensuring that individuals are appropriately paid as either employees or independent contractors at Indiana University. Fiscal officers and independent contractors (individual service providers) should be aware of current university guidelines regarding independent contractor determinations. Fiscal officers are expected to know the service provider’s organizational identity, as defined by the IRS, when attempting to secure an agreement for their services.

Indiana University Independent Contractor Guidance

Based on the criteria set forth by the IRS and DOL, the university has simplified the requirements for independent contractor determinations into the following five policy criteria, as reflected in FIN-ACC-630: Independent Contractor versus Employee Status Determination. All five criteria must be met for an individual to be considered and paid as an independent contractor.

1. The university does not control or direct the means or methods used to perform the task. That is, the individual is and will continue to be free to use whatever means and methods he/she deems appropriate to accomplish the task.
2. The task or service being performed is outside the regular course of the university’s primary business purpose. The primary business purpose of the university includes teaching and instruction (both in credit and non-credit granting courses), research, and public service.
3. The individual is engaged in an independently established business, trade, occupation, or profession and is responsible for (a) providing any equipment, tools, and materials required to perform the task and (b) is responsible for hiring/managing/firing any subcontractors or assistants that are required to complete the task. Services being provided by the independent contractor are also regularly provided to other clientele outside of the university.
4. The task is of short duration and is not indicative of an ongoing relationship. Tasks are completed within a 180 consecutive day period or less will be treated as being completed within a short duration.
5. Documentation exists with the university which spells out the task or service(s) to be performed. The agreement or related documents must contain:
   • Contractor name, address, telephone #
   • Nature and location of services to be performed
   • Performance schedule (starting and ending dates, etc.)
   • Departmental contact person and address
   • Payment method (per piece, per job, installments, etc.)
   • Independent contractor completes supplier registration process in the Indiana University Procurement System and submits invoices to receive payment.

If the service provider meets all the five criteria detailed above, they are eligible to be paid as an independent contractor. If not, the individual should be paid as an employee through payroll.

To assure adherence with Indiana Code 4-2-10-10.5 and 35-44-1-1.4, all university employees who are providing services outside of their regular job duties must be paid as employees through the regular university payroll process. NOTE: An ICQ is required for any independent contractor that has also been paid through payroll within the last 365 days, even if all 5 criteria are met above.

Work Performed on a Grant

Grant applications, grant proposals, and/or grant award documents can potentially contain classification language (employee vs. independent contractor) in regards to the individual(s) who will be performing services for the grant. Even when a grant classifies an individual as an independent contractor, a department cannot pay an individual as an independent contractor unless all policy criteria above are met or an approved ICQ is obtained.  This is due to the university ultimately being responsible for the liability of misclassification risk. Liability of misclassification risk cannot be mitigated by grant language

ICQ Exception Process

Exceptions to the above may be considered via the ICQ with approval from the unit’s VP/Provost/Chancellor or designee. This approval is required to be included with the ICQ submission. UCO Tax will analyze the ICQ in conjunction with General Counsel and apply a payment method determination. Please note that ICQ exception determinations are made for each engagement with the independent contractor. Before services commence, an ICQ must be submitted and a determination made for all individuals that do not meet all five criteria outlined in the policy.

NOTE: An ICQ is required to be submitted for any individual currently paid (or paid within the last 365 days) as an IU employee, even if all five policy criteria are met.

1. ICQ Process Detailed

The ICQ form is an online exception request that is submitted to UCO Tax. The contracting unit is required to submit the ICQ form before a review can be conducted by UCO Tax. UCO Tax may issue follow-up questions which will be specific to the services being provided by the independent contractor. The form’s submitter and additional unit contacts will be required to provide clarification.

2. Service Written Agreement (Statement of Work) Review

Per the five organizational review criteria outlined within the Indiana University independent contractor guidance portion of this standard, UCO Tax requires a written agreement for all independent contractor services being provided. The preferred method is through a contract or statement of work (SOW). UCO Tax utilizes SOWs to apply payment method determinations. The description of the work being provided must be as specific as possible on the SOW. This should include measurable aspects that provide quantifiable and qualifiable information as much as possible. Vague and open-ended descriptions are not to be used in the SOW for independent contractor agreements.

For convenience, UCO Tax has created an SOW template for units to utilize as a starting point. This file should supply the individual’s service details based on the arrangement set-up.

UCO Tax has also compiled examples of SOWs that have been submitted and approved.

In the event UCO Tax identifies significant risks and/or challenges with a payment method determination, UCO Tax will initiate a request for a review by IU’s Office of General Counsel (Legal). Form submitters (and associated contracting unit contacts) may be required to provide additional clarification of the services being provided if IU Legal has follow-up questions during their review. Subsequently, UCO Tax, based on direction from IU Legal, will provide a payment method determination.

Additional Reference Information

IRS Guidance

UCO Tax, and Indiana University overall, are guided by IRS Topic #762 to navigate the application of a payment method for how an individual or an organization are eligible to receive payment for services being provided. These determinations use IRS-defined relationship levels between individuals providing services and the organization receiving them to define the degree of control regarding the service(s) being provided. The university must consider all evidence of the degree of control and independence in this relationship. The more significant the control by the university, the more likely the individual should be classified as an employee. The facts that provide this evidence fall into three categories – behavioral control, financial control, and relationship of the parties.

1. Behavioral Control – Behavioral control covers facts proving the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
2. Financial Control – Financial control determines if the business has a right to direct or control the financial and business aspects of the worker’s job. This includes:

• • The extent to which the worker has unreimbursed business expenses.
  • The extent of the worker’s investment in the facilities or tools used in performing services.
  • The extent to which the worker makes his or her services available to the relevant market.
  • How the business pays the worker, and
  • The extent to which the worker can realize a profit or incur a loss.

3. Relationship of the Parties – Relationship of the parties determines the type of relationship between the two parties overall. This includes:

• • Written contracts or oral agreements describing the relationship the parties intended to create.
  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay.
  • The permanency of the relationship.
  • The extent to which services performed by the worker are a key aspect of the regular business of the company.

DOL Guidance

The DOL uses the Fair Labor Standards Act to define when an individual would be considered an employee vs an independent contractor. To simplify the Fair Labor Standards Act, a worker is an employee if they are economically dependent on the employer for work. Conversely, a worker is an independent contractor if they are in business for themselves. The DOL provides six economic reality factors to help in making this determination.

• Opportunity for Profit and Loss Depending on Managerial Skill: Does the worker earn profits or suffer losses through their own independent effort and decision making?
• Investment by the Worker and the Potential Employer: Has the worker made investments that are capital or entrepreneurial in nature?
• Permanency of the Work Relationship: What is the nature and length of the work relationship?
• Nature and Degree of Control: Who controls the economic aspects of the working relationship?
• Extent to Which Work Performed is an Integral Part of the Employer’s Business: Is the work critical, necessary, or central to the potential employer’s principal business?
• Skill and Initiative: Does the worker use their own specialized skills together with business planning and effort to perform the work and support or grow the business?

Requirements

1. Units must review policy FIN-ACC-630: Independent Contractor versus Employee Status Determination and this standard before engaging and paying an independent contractor.
2. If a service provider meets all five of the policy criteria detailed above, they are eligible to be paid as an independent contractor. If not, the individual should be paid as an employee through payroll.
3. An ICQ is required to be submitted for any individual currently paid (or paid within the last 365 days) as an IU employee, even if all five criteria are met above.
4. Documentation or agreement (Statement of Work) for the services is required for all independent contractor payments.
5. Any exceptions require the submission of an ICQ form with the approval from the unit’s VP/Provost/Chancellor or designee. An ICQ exception must be received before services are provided by the individual.
6. If an exception is granted through the ICQ process by UCO Tax, the ICQ email approval from UCO Tax must be obtained and attached to the corresponding (payment) requisition created for it within BUY.IU, as a supporting document/attachment.
7. If an exception is requested through the ICQ process, units must communicate with the potential independent contractor the existence of Indiana University’s current policy and standard before work is performed to allow for a thorough review process.
8. Units who have received an ICQ exception approval from UCO Tax and/or General Counsel must acknowledge the responsibility for employment risk that could be incurred by the contracting unit. This could include, but not be limited to, associated fines, penalties, and interest with this misclassification that would need to be covered by the unit.