Dear Reader:
The following document was created from the MTAS electronic library known as MORe (www.mtas.tennessee.edu/more). This online library is maintained daily by MTAS staff and seeks to represent the most current information regarding issues relative to Tennessee municipal government.
We hope this information will be useful to you; reference to it will assist you with many of the questions that will arise in your tenure with municipal government. However, the Tennessee Code Annotated and other relevant laws or regulations should always be consulted before any action is taken based upon the contents of this document.
Please feel free to contact us if you have questions or comments regarding this information or any other MORe material.
Sincerely,
The University of Tennessee
Municipal Technical Advisory Service
1610 University Avenue
Knoxville, TN 37921-6741
865-974-0411 phone
865-974-0423 fax
www.mtas.tennessee.edu
Types of Employment Relationships
All employers hire others to perform services. Some services must be performed routinely whereas others are needed less frequently, perhaps only once. Those hired by the employer to perform routine activities generally are considered to be employees and are paid taxable wages based on a salary or an hourly rate. Other services needed by the employer that occur infrequently generally are performed by contractors. Contractors have more than one employer and typically are paid by the job instead of with wages.
Most employment relationships are clearly identifiable by whether the one hired is an employee of the organization or a contractor. Other times, however, depending on the services needed by the employer, the distinction is not easily defined.
Employer/Employee Relationship
Municipalities offer a variety of services to their citizens relating to public safety, health and welfare. Typically, these activities are labor intensive and require the talents of individuals who have specialized skills and training. Because these services are part of the ongoing mission of the organization, individuals charged with delivering the services are hired as employees of the municipality.
As with any other employer, a municipal government is required to follow Internal Revenue Service guidelines regarding payroll reporting responsibilities. Standard application of payroll tax withholding from employees’ gross wages based on the IRS Publication 15, Circular E, Employer’s Tax Guide must be followed, including routine tax filings and annual reporting of employee wages.
Employer/Independent Contractor Relationship
Situations also occur that require knowledge and skills exceeding the ability of those employed by the city. In these cases, the decision makers of the local government find it necessary to hire on a one-time basis person(s), firm(s), or corporation(s) who are specialists in a specific field of endeavor to solve a problem or provide a service. Since the need is tied specifically to a single event, there is no need to employ the provider on an ongoing basis. Here, the one providing the service is engaged as an independent contractor under terms defined by a written agreement or contract.
The employment contract between the party requiring the service and the party providing the service defines the nature of what is to be performed and the amount of compensation to be paid to the contractor. If the contractor is not a corporate entity, the IRS requires the municipality to prepare a federal Form 1099 reporting the amount paid to the person or firm providing the service.
Employee or Independent Contractor?
The circumstances mentioned above clearly define the employment relationship between the person or persons needing the service performed and the person or persons delivering the service. Other situations, however, are recurrent, and the employment relationship is more difficult to determine.
It is critical that a city properly classify the employment relationship with those hired to perform services. Improper classification of an employee as an independent contractor may result in the city being held liable for the employee’s taxes plus additional penalties.
Determining the Employment Relationship
How can a municipality determine whether the employment relationship between the city and the one hired is that of employer/employee or employer/independent contractor? The Internal Revenue Service provides guidance to help one hiring the services of another determine the classification of the employment relationship. This guidance can be reduced to the evaluation of three factors or categories of control. These categories are:
Behavioral Control
Behavioral control relates to the amount of direction and control the one who hires exercises over the one who performs the services. Questions to be answered include:
If the hiring party provides direct supervision, training, and instruction and schedules the time when services are to be performed, the relationship is probably that of employer/employee.
If the one who hires does none or very little of the aforementioned, the relationship is probably that of employer/independent contractor.
Financial Control
Financial control relates to the financial risk taken by the parties in the relationship. Who of the two is most likely to risk a loss from the employment relationship?
If the one who hires owns most of the equipment used in the delivery of the service, is the only one, or one of a very few, for whom the one hired performs the service, and takes the financial risk of profit or loss associated with the service, the relationship is probably that of employer/employee.
If the one who is hired to perform the service provides the equipment, has many customers for whom similar services are performed, and takes the financial risk of earning a profit or suffering a loss on the venture, the relationship is probably that of employer/independent contractor.
Relationship of the Parties
What is the nature of the relationship between the hiring party and the one who is performing the service?
If the hiring party has an expectation that the services needed will be ongoing, pays the one providing the service by the hour or some other routine method, and provides fringe benefits such as health insurance or workers’ compensation to the one hired to perform the service, the relationship is probably that of employer/employee. If the hiring party issues a written contract specifying the scope of services, length of time, and compensation without ongoing fringe benefits such as health insurance and workers’ compensation, the relationship is probably that of employer/independent contractor.
Additional Resources
The IRS website contains additional material to assist in the determination of the employer/employee relationship. Twenty (20) factors for the employer to consider to determine whether a worker is an employee or an independent contractor are presented. If you are not confident of making the employment relationship determination based on the information presented here and you prefer to let the IRS make that determination for you, IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding [1] with instructions for completion. Additional information is available online at www.irs.gov [2].
Links:
[1] http://www.irs.gov/pub/irs-pdf/fss8.pdf
[2] http://www.irs.gov
DISCLAIMER: The letters and publications written by the MTAS consultants were written based upon the law at the time and/or a specific sets of facts. The laws referenced in the letters and publications may have changed and/or the technical advice provided may not be applicable to your city or circumstances. Always consult with your city attorney or an MTAS consultant before taking any action based on information contained in this website.
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