Classifying Employees vs. Independent Contractors

Does employment status really matter? The Internal Revenue Service says “yes” but the Service Contract Act says “no” when the Department of Labor enforces The Act.

The Internal Revenue Service says employee status is important because it determines if the federal service contractor must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. The contractor normally does not have to withhold or pay any taxes on an independent contractor. The earnings of a person working as an independent contractor are subject to self-employment tax. Classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. 

The federal service contractor should consider three factors to better determine the proper employment status: Behavioral Control, Financial Control and Relationship of the Parties.

According to the IRS, in general, an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. The federal service contractor should consider all evidence of the degree of control and independence in the employer and employee relationship. Whether an employee is an independent contractor or employee depends on the facts in each situation.

The Service Contract Act views the employment relationship differently. In general, any person who performs work called for by a contract, or a portion of a contract, subject to the Service Contract Act, is a service employee. A person's status as an “independent contractor” is immaterial in determining coverage under the Service Contract Act and all such persons performing the work of service employees must be compensated in accordance with the Service Contract Act's requirements, including fringe benefit, vacation, holiday, and sick leave payments.

Refer to the Code of Federal Regulations CFR Title 29 §4.155 addressing “independent contractors.” If the contract is subject to the Service Contract Act, then all such persons performing the work of service employee must be compensated in accordance with the Act’s requirements. Employment status does not matter. (Scroll down to 4.155 on the link.)

 §4.155   Employee coverage does not depend on form of employment contract.

The Act, in section 8(b), makes it plain that the coverage of service employees depends on whether their work for the contractor or subcontractor on a covered contract is that of a service employee as defined in section 8(b) and not on any contractual relationship that may be alleged to exist between the contractor or subcontractor and such persons. In other words, any person, except those discussed in §4.156 below, who performs work called for by a contract or that portion of a contract subject to the Act is, per se, a service employee. Thus, for example, a person's status as an “owner-operator” or an “independent contractor” is immaterial in determining coverage under the Act and all such persons performing the work of service employees must be compensated in accordance with the Act's requirements.

It is incumbent upon the federal service contractor to properly classify the employment status of every individual to remain compliant, avoid retroactive payments of taxes & compensation, penalties & interest, as well as making false claims against the federal government, their client. 

AssuredPartners has a team of government contractor professionals who help clients working under government contracts to drive growth and provide competitive and compliant insurance solutions. To learn more about these strategic solutions for domestic and international service and construction companies, visit AssuredPartners Government Contractor Solutions.