For the unwary business owner, the terms “independent contractor” and “employee” may seem to be a question of whether the business owner or manager elects to issue a W-2 or 1099 to the worker in question. However, these words represent important distinctions that have been specifically defined by the Internal Revenue Service. A business owner who fails to properly classify its workers can suffer significant penalties and financial detriment.
Whether someone who works for you is an employee or an independent contractor is an important question. The answer determines your liability to pay and withhold Federal income tax, Social Security and Medicare taxes, and Federal unemployment tax. In general, someone who performs services for you is your employee if you can control what will be done and how it will be done.
The IRS test for determining whether an individual is an independent contractor or an employee often is termed the “right-to-control test” because each factor is designed to evaluate who controls how work is performed. Under IRS rules and common-law doctrine, independent contractors control the manner and means by which contracted services, products, or results are achieved. The more control a company exercises over how, when, where, and by whom work is performed, the more likely the workers are to be considered employees, not independent contractors.
A worker does not have to meet all 20 criteria to qualify as an employee or independent contractor, and no single factor is decisive in determining a worker’s status. The individual circumstances of each case determine the weight the IRS assigns to these different factors.
NOTE: Employers who are uncertain about how to classify a worker can request an IRS determination by filing Form SS-8, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” However, some caution that the IRS usually classifies workers as employees whenever their status is not definite and clear-cut. In addition, employers that request an IRS determination lose certain protections against liability for misclassification.
In many circumstances, the issue of who has the right to control is often not clear and the Tax Code does not define the term “employee.” So the IRS developed the “20-Factor Test” to arrive at an answer. It is not necessary that a business owner have all the factors in its favor to be able to treat a worker as an independent contractor, but the classification of a worker as an independent contractor is more likely to pass the common law test if more important factors point to independence.
The 20 factors considered under the right to control test, and utilized to determine the validity of an independent contractor classification include:
• Level of instruction. If the company directs when, where, and how work is done, this control indicates a possible employment relationship.
• Amount of training. Requesting workers to undergo company-provided training suggests an employment relationship since the company is directing the methods by which work is accomplished.
• Degree of business integration. Workers whose services are integrated into business operations or significantly affect business success are likely to be considered employees.
• Extent of personal services. Companies that insist on a particular person performing the work assert a degree of control that suggests an employment relationship. In contrast, independent contractors typically are free to assign work to anyone.
• Control of assistants. If a company hires, supervises, and pays a worker’s assistants, this control indicates a possible employment relationship. If the worker retains control over hiring, supervising, and paying helpers, this arrangement suggests an independent contractor relationship.
• Continuity of relationship. A continuous relationship between a company and a worker indicates a possible employment relationship. However, an independent contractor arrangement can involve an ongoing relationship for multiple, sequential projects.
• Flexibility of schedule. People whose hours or days of work are dictated by a company are apt to qualify as its employees.
• Demands for full-time work. Full-time work gives a company control over most of a person’s time, which supports a finding of an employment relationship.
• Need for on-site services. Requiring someone to work on company premises—particularly if the work can be performed elsewhere—indicates a possible employment relationship.
• Sequence of work. If a company requires work to be performed in specific order or sequence, this control suggests an employment relationship.
• Requirements for reports. If a worker regularly must provide written or oral reports on the status of a project, this arrangement indicates a possible employment relationship.
• Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of employment relationships, unless the payments simply are a convenient way of distributing a lump-sum fee. Payment on commission or project completion is more characteristic of independent contractor relationships.
• Payment of business or travel expenses. Independent contractors typically bear the cost of travel or business expenses, and most contractors set their fees high enough to cover these costs. Direct reimbursement of travel and other business costs by a company suggests an employment relationship.
• Provision of tools and materials. Workers who perform most of their work using company-provided equipment, tools, and materials are more likely to be considered employees. Work largely done using independently obtained supplies or tools supports an independent contractor finding.
• Investment in facilities. Independent contractors typically invest in and maintain their own work facilities. In contrast, most employees rely on their employer to provide work facilities.
• Realization of profit or loss. Workers who receive predetermined earnings and have little chance to realize significant profit or loss through their work generally are employees.
• Work for multiple companies. People who simultaneously provide services for several unrelated companies are likely to qualify as independent contractors.
• Availability to public. If a worker regularly makes services available to the general public, this supports an independent contractor determination.
• Control over discharge. A company’s unilateral right to discharge a worker suggests an employment relationship. In contrast, a company’s ability to terminate independent contractor relationships generally depends on contract terms.
• Right of termination. Most employees unilaterally can terminate their work for a company without liability. Independent contractors cannot terminate services without liability, except as allowed under their contracts.
The above-listed factors are used for the purpose of determining independent contractor status by the Internal Revenue Service.
Whether or not an employee is an independent contractor is also important with regard to many other aspects of the law such as the applicability of the U.S. Fair Labor Standards Act, the necessity of Workers Compensation insurance and many other employer-employee issues. The tests used to consider a workers status under these laws are similar to the IRS’ 20-Factor Test but not the same.
Appropriate legal counsel is always wise any time a decision about a worker’s status is made. Employers are strongly encouraged to carefully review the law with your company’s lawyer. Should your ultimate determination be that you wish to proceed to hire a worker as an independent contractor, it is also essential that an Independent Contractor Agreement be executed.
Douglas H. Flint is senior partner in the law firm of Flint, Connolly & Walker, LLP in Canton, Georgia, where he represents and assists both businesses and individuals with their legal matters.