Introduction
The university processes expenditures for services of individuals and business entities through one of two methods: employee appointments via the payroll system or contractual services via purchase orders. The information below provides guidance to departments in selecting between these two methods to ensure appropriate treatment for tax purposes.
All payments for services are considered taxable income to the recipient. If an employer-employee relationship exists, the payments are considered wages subject to federal withholding tax and applicable FICA contributions. Wages are reported annually to the IRS and individual on Form W-2. If no employee-employer relationship exists, then the payee is considered to be an independent contractor. Independent contractors are individually responsible for remitting quarterly estimated income tax payments and self-employment (SECA) tax contributions. Payments to most independent contractors in excess of $2,000 are reported annually on IRS Form 1099-MISC or Form 1099-NEC.
There is no statute or regulation that defines who should be an employee or who should be an independent contractor. The IRS and the courts rely on common law principles to make this determination. These principles include, but aren’t limited to, an evaluation of the degree of behavioral and financial control exercised by the university and the payee. Because the facts and circumstances of each transaction are different, no particular common law principles have greater weight than others; although the IRC instructs the IRS to take into consideration the understanding of both parties about the nature of the business relationship.
Prohibition of Dual Classification
IRS regulation 31.3402(e)-1 suggests that an individual not receive both wages and independent contractor compensation during the same period of time from the same employer. For purposes of administering this prohibition, the university is using 12 months as a measure of this time period. This means that an individual will not be approved as a vendor if the individual was previously employed by the university within the last 12 months. Exceptions to this rule must be approved by both Procurement and Tax Services, who will evaluate all of the facts and circumstances.
Department Responsibilities and Administrative Review and Oversight
Generally, the IRS has no issue with individuals who are paid taxable and reportable W-2 wages. The problem almost always arises when individuals who should be paid as employees are classified inappropriately as independent contractors. These people can usually be easily identified because they don’t have a bona fide business that is properly registered with the State and City, and will be paid under their own social security number. Departments should work carefully with the Procurement before classifying these people as independent contractors. Procurement and Controller’s Offices reserve the right to make the final worker classification determination. Departments must complete an Independent Contractor Checklist for any vendors that are either an individual, single-member LLC, or sole proprietorship and are providing services to the university.
Updated 1/26/2026
