Copyright © 2002, United States Conference of Catholic Bishops, Inc. All rights reserved.
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VI. Compensation of Lay Employees
of the Church: Employee
or Independent Contractor?
The mission of the Church requires the efforts of the ordained, the professed, and the laity. When the efforts are in the form of paid compensation to lay people, it is important to record and report the compensation properly. Two methods are prescribed by the Internal Revenue Service (IRS) to report compensation: Form W-2 for employees, and Form 1099-MISC for independent contractors. Once an employing entity determines the employment status of a lay worker, the reporting procedures are quite straightforward and perfunctory. The challenge lies in the determination of the employment status.
At either extreme, there is little debate. A parish classifies a full-time lay worker with benefits (e.g., a maintenance worker, secretary, or school teacher) as an employee and thus withholds federal, state, and local taxes; withholds and matches Social Security (FICA) taxes; and reports compensation and withholdings on Form W-2. A parish that hires an outside service to repair the boiler considers the service to be an independent contractor and issues a check with no withholding. At the end of the calendar year, if such payments are made to non-corporate entities (usually individuals), are for services rendered (not for materials), and have accumulated to $600 or more for the year, then the parish will issue that person a Form 1099-MISC.
It is the in-between worker that becomes a matter of dispute: the once-a-week organist, part-time housekeeper, or volunteer youth worker to whom a stipend is paid. As a general rule, when in doubt, consider the worker an employee and issue Form W-2 for three reasons:
However, there are legitimate reasons to accurately determine the employment status of a lay worker, rather than simply to issue a Form W-2. Perhaps the parish has no other employees and would like to avoid the added quarterly and annual reporting associated with withholding taxes if the parish considers the worker an employee. Or perhaps the worker prefers the independent contractor status for tax benefits, whether real or perceived. Preferences by the worker or parish will not govern the classification in themselves, but these may be reasons for a parish to ascertain the proper classification.
- The worker generally prefers Form W-2. Usually unsophisticated in tax matters, workers do not want to file the extra forms required of an independent contractor, nor pay both sides of the Social Security tax (self-employment tax) and have no withholding throughout the year.
- The IRS prefers Form W-2 because historically they have much greater compliance in tax payments with Form W-2 versus Form 1099-MISC. This results in greater scrutiny of tax returns for filers who receive Form 1099-MISC than those who receive Form W-2.
- The government will get its money either way. The worker using Form 1099-MISC must pay income tax and both sides of the Social Security tax. When Form W-2 is used instead, the parish pays one half of the Social Security tax. Knowing this, the parish and worker can agree on an adjusted wage rate reflecting the Social Security tax burden put upon the parish for issuing Form W-2.
Up through 1987 there was limited guidance to determine employment status, so such determinations were quite subjective. Then in 1987 the IRS announced,
As an aid to determining whether an individual is an employee under the common law rules, twenty factors have been identified as indicating whether sufficient control is present to establish an employer-employee relationship. The twenty factors have been developed based on an examination of cases and rulings considering whether an individual is an employee.The IRS lists the twenty factors in Revenue Ruling 87-41. Each factor's abbreviated title follows:
However, the IRS has in recent years decreased reliance on the twenty factors and instead increased emphasis on the three-category approach. The following excerpt from the IRS website (www.irs.gov) explains the new approach:
- Services Rendered Personally
- Hiring, Supervising, and Paying Assistants
- Continuing Relationship
- Set Hours of Work
- Full Time Required
- Doing Work on Employer's Premises
- Order or Sequence Set
- Oral or Written Reports
- Payment by Hour, Week, Month
- Payment of Business Expenses
- Furnishing of Tools
- Significant Investment
- Realization of Profit or Loss
- Working for More Than One Firm
- Services Available to Public
- Right to Discharge
- Right to Terminate...
Where there is no controlling statute, a worker's status is determined by applying the common law test, which applies for purposes of FICA, FUTA, Federal income tax withholding, and the Railroad Retirement Tax Act. A worker's status under the common law test is determined by applying relevant facts that fall into three main categories: behavioral control, financial control, and the type of relationship itself. In each case, it is very important to consider all the facts—no single fact provides the answer.When applying these criteria to a particular employment scenario, a preponderance of factors usually emerges. However, in uncertain cases, employers have the option of filing Form SS-8: a form designed by the IRS that asks in essence the twenty questions outlined above. The IRS is usually not quick in responding to a Form SS-8 inquiry; and if the employment status is so uncertain, it is likely that the IRS will rule in favor of employee status.
Behavioral Control. These facts show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done—as long as the employer has the right to direct and control the work. For example:
Financial Control. These facts show whether there is a right to direct or control the business part of the work. For example:
- Instructions—If you receive extensive instructions on how work is to be done, this suggests that you may be an employee. Instructions can cover a wide range of topics, for example: how, when, or where to do the work, what tools or equipment to use, what assistants to hire to help with the work, and where to purchase supplies and services. If you receive less extensive instructions about what should be done, but not how it should be done, you may be an independent contractor. For instance, instructions about time and place may be less important than directions on how the work is performed.
- Training—If the business provides you with training about required procedures and methods, this suggests that the business wants the work done in a certain way, and you may be an employee.
Relationship of the Parties. These are facts that illustrate how the business and the worker perceive their relationship. For example:
- Significant Investment—If you have a significant investment in your work, you may be an independent contractor. While there is no precise dollar test, the investment must have substance. However, a significant investment is not necessary to be an independent contractor.
- Expenses—If you are not reimbursed for some or all business expenses, then you may be an independent contractor, especially if your unreimbursed business expenses are high.
- Opportunity for Profit or Loss—If you can realize a profit or incur a loss, this suggests that you are in business for yourself and that you may be an independent contractor.
- Employee Benefits—If you receive benefits, this is an indication that you are an employee. If you do not receive benefits, however, you could be either an employee or an independent contractor.
- Written Contracts—A written contract may show what both you and the business intend. This may be very significant if it is difficult, if not impossible, to determine status based on other facts.
Finally, diocesan entities often benefit from contributed services. A parishioner may volunteer to clean the church every week, or a carpenter may replace the windows and only charge for materials. These acts of charity are welcomed, but often the volunteer asks for a tax receipt for the contributed services. After all, the volunteer saved the church hundreds of dollars in labor costs, and the volunteer could have been making money elsewhere had he or she not been volunteering.
While it is permissible to write a letter thanking the volunteer for donating his or her time that saved the church $500 in labor costs, it is not permissible to give the volunteer a tax receipt or include the value of the services on the volunteer's annual contribution statement. The value of contributed personal labor is not deductible.