May 2, 2011
By Douglas H. Flint
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:
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. Because the Fair Labor Standards Act applies only to employer-employee relationships, independent contractors are not covered by FLSA provisions. Court decisions interpreting FLSA coverage rules require that employers use an “economic reality” test in determining whether an employment relationship exists with respect to a given worker.
Similar to other tests, the economic reality test focuses on the degree of control exercised by the employer as an essential factor in determining whether an employer/employee relationship exists. While no single factor is controlling or decisive in determining whether an employment relationship exists, the facts and circumstances that courts and federal enforcement officials examine in deciding whether an individual is an employee or an independent contractor are:
Because there are multiple sets of standards to be considered and applied when making a decision or determination about a worker’s status, consultation with your company’s lawyer is strongly recommended. Employers should note that it is extremely important to prepare and execute an Independent Contractor Agreement should the employer determine that he or she intends to hire a worker as an independent contractor.
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 a partner in the law firm of Flint, Connolly & Walker, LLP where he represents businesses and individuals in various legal matters.