How to make payments to employees.
Who is an employee?
An employee is a person who performs a service and receives any compensation reportable on the IRS W-2 (Wage and Tax Statement) at the end of the calendar year. Find more details in UW System Policy – Determination of Employee vs. Independent Contractor Status.
Note: Contrary to popular misconception, all hourly students are employees and receive an IRS W-2 (Wage and Tax Statement).
Who is NOT an employee
The following classifications of people on the Human Resource System (HRS)/Payroll are not considered employees since they do not receive an IRS W-2 (Wage and Tax Statement) at the end of the calendar year:
- Advanced Opportunity Fellow (SA001)
- Fellow (SA002)
- Trainee (SA013)
- Postdoctoral Fellow (PD003)
- Postdoctoral Trainee (PD004)
- Grad Intern/Trainee (PD001)
- Scholar (SA010)
- Any zero dollar appointment
Note: If a person has one of the above classifications that are not considered employees and also has an employee appointment classification, then the employee classification makes them an employee of the UW.
Employees of other UW System campuses
Any UW System campus employee is considered an employee of the UW since all UW System Campuses are paid through a central payroll system and report to the IRS as one entity/unit.
What payment mechanism should be used to pay employees?
Internal Revenue Code (IRC) Section 3402(e) requires treatment of all remuneration paid to employees to be considered wages if more than 50% of the remuneration is for wages. Therefore, UW System and UW–Madison take a conservative approach and if the person is currently a UW System employee, all payments will be deemed to be wages.
All tax reportable payments made to UW employees must be made through Payroll, with limited exceptions outlined below:
- An independent contractor paid during the first half of the year who becomes an employee later in the year.
- An employee that owns a private business with its own Federal Employer Identification Number (FEIN/EIN) doing work that is completely different and distinct from their employment, where no employer/employee relationship exists for the service based on Determination of Employee vs. Independent Contractor Status.
- Payments for rents.
- Payments for Royalties (Definition, Payment Processing, and Tax Reporting).
- Payments to employees for participating in Institutional Review Board (IRB) approved Research Subject Studies, can be paid either through (1) Payroll, (2) Payment to Individual Report (PIR), or (3) any payment method available for making payments to non-employees who participate in IRB approve Research Subject Studies. The same policies and rules apply to both non-UW employees and UW employees who participate in IRB approve Research Subject Studies.
Note: Employee business expenses, with a documented business purpose, are not tax reportable and must be processed through the e-Reimbursement System (UW Accountable Plan).
It is the responsibility of each paying Center/Department/Unit/Division to ensure all tax reportable payments made to UW employees are made through Payroll, with limited exceptions that are outlined above. This includes employees of all UW System Campuses since–as mentioned above–all UW System Campuses are paid through a central payroll system and report to the IRS as one unit.
The determination of employee vs. independent contractor should be made by the paying department working with (1) their divisional Business Deans Office and (2) their Divisional Payroll/HRS Office using the following:
- Use the Employee/Independent Contractor Assessment Tool.
This tool was developed for the specific purpose to comply with UW System Policy – Determination of Employee vs. Independent Contractor Status. The university is required to comply with the policy and tool parameters to treat all people appropriately and classify them correctly or the IRS can fine and penalize the UW.
- Services being performed before/after their employment must be reviewed based on the requirements of UW System Policy – Determination of Employee vs. Independent Contractor Status prior to the services being performed. Each service must be reviewed separately/independently.
Accounting Services responsibility
Accounting Services reviews payments to all individuals to identify if any of these individuals are UW employees before any payment is made. The reason for doing so is that payments to employees that are considered tax reportable income MUST be processed through the Payroll System so that they are taxed (federal, state, FICA) and reported on the employee’s W-2 (Wage and Tax Statement) appropriately at the end of each calendar year. The only exceptions to this rule are listed above.
From the Disbursements/AP side we only look within a calendar year as our main concern is that the UW does not issue a W-2 (Employment) and a 1099-MISC (Independent Contractor) in the same calendar year. Issuing a W-2 for employment and a 1099-MISC for Independent contractor work, in the same calendar year, puts the UW at risk with the IRS of incurring fines and penalties. This is of special concern when the person is paid after the original employment position is terminated and hired by any other department or campus, no matter which department the work is done for, since the IRS considers the UW as one entity no matter what department or campus is the recipient of the additional service.
The IRS reviews the UW’s W-2 and 1099-MISC files each year, therefore as part of the regular procedures, UW System Administration queries all employee payments made through A/P to assure this does not happen.
The PIR/DP/PO service payment must be for services that are completely different and distinct from their employment, where no employer/employee relationship exists for the service based on UW System Policy – Determination of Employee vs. Independent Contractor Status.
As a rule, if there is any doubt as to whether the services being performed by any person is employment or independent contractor, the UW should use the employment route; with employment (1) appropriate taxes (Federal, State, FICA) are withheld and reported, and (2) additional issues like worker’s compensation, insurance, and other liabilities are covered by the UW.
UW System Administration and UW-Madison run periodic audits to make sure the only tax reportable payments to employees paid through Accounting Services meet one of the above exceptions. The intent of this process is to avoid an IRS audit, which puts UW at risk for having to pay all the taxes (federal, state, FICA) for the employee if it is found the UW paid the employee through Accounts Payable instead of Payroll. Employee payments for tax reportable income also subjects the individual employee to an IRS audit of their personal tax returns. If any tax reportable payments to employees that do not meet one of the exceptions listed above are identified in our audits, these payment will automatically be sent by the Tax Compliance Office to Payroll for taxation and will be reported on the employee’s W-2 (Wage and Tax Statement).
Prior to sending any payments through any UW payment mechanisms (PIR, DP, PO, E-Reimbursement, etc.), it is the responsibility of each paying Center/Department/Unit/Division to ensure these submissions do not include any employee tax reportable payments unless they are one of the allowable exceptions above.
- UW System Policy - Determination of Employee vs. Independent Contractor Status
- UW OHR Policy - Employment and Independent Contracting
- Employee/Independent Contractor Determination Questionnaire (PDF)
- Research and Sponsored Program (RSP) - Guidance for Contracting External Services on Sponsored Projects (see assessment tool)
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