Independent Contractor or Employee
Below you will find 20 factors in determining whether someone is an
independent contractor or an employee. They can be boiled down to three
broad categories:
- Behavioral Control - Facts that substantiate the right to direct
or control the details and means by which the worker performs the
required services are considered under behavioral control. Factors
such as training provided by the business, degree of supervision,
and who controls the end product are weighed under this test.
- Financial Control - The IRS will look to see if a worker has
significant financial investment or unreimbursed expenses. They
will also look to see if the workers services are available to
general public and how the worker is paid. In other words, does
the worker have an opportunity for profit or loss.
- Relationship of parties involved - the substance of the relationship
between the parties governs the worker's status, not the label.
What is the parties' intent? It is very important to utilize a
written agreement.
To assist taxpayers with classifying workers, the IRS issued Revenue
Ruling 87-41. This ruling lists 20 factors that are taken into consideration
when classifying a worker:
- Instructions - Does the worker comply with instructions or devise
his own methods?
- Training - How is training obtained? Independent contractors
receive no training.
- Integration - Are the services performed by the worker integrated
into the business?
- Services rendered personally - Is the work only performed by
the worker or can they delegate work to someone else? Such delegation
supports independent contractor.
- Hiring and supervising - Does the worker hire and supervise others?
- Continuing relationship - Does the worker continually work for
the business or are there significant periods of inactivity? Recurring
work indicates employee.
- Set hours of work - Who sets the work hours? Independent contractors
can work whenever they want.
- Full-time required - Is this a full-time job? If the person is
working full-time, he or she does not have opportunity to work
for someone else and control is implied, indicating employee.
- Doing work on employer's premesis - Where is the work performed?
If the work could be somewhere else, but is done on the employer's
premesis, control is implied.
- Order of sequence of work performed - Who decides what and when
work is performed? If work must be performed in a sequence ordered
by the employer, control is evident.
- Oral or written reports - Are reports required to the business?
Independent contractors generally do not have to account for their
actions.
- Payment by the hour, week or month - How is the worker paid?
Standard pay amounts or periods indicates employee relationship.
- Payment of business and/or traveling expenses - Is the worker
reimbursed for business related expenses? If so, this indicates
control by the employer.
- Furnishing of tools and materials - Who provides the tools necessary
to perform this work? If most or all tools are provided by the
employer, this is an indication of an employee relationship.
- Significant investment - Is there a significant investment by
the worker in their business?
- Direct interest in the profitability of the work accomplished
- Does the worker bare the risk of gain and loss from the project
or is payment guaranteed in amount (indicating emplyee)?
- Working for more than one firm at a time - Indicates independent
contractor.
- Making services available to the general public - Indicates independent
contractor.
- Right to discharge worker - Can the worker be fired? Usually,
an independent contractor cannot be fired as long as they produce
the desired results.
- Right to terminate the work relationship - There could be liability
if the independent contractor terminated the work before completion.
Business owners are required to classify workers as either employees
or independent contractors. From the business owner's perspective,
independent contractors are less costly than employees. The pay and
treatment of employees is significantly regulated by Federal and state
employment laws. On the other hand, if a true independent contractor
relationship exists, the employer enjoys significant financial and
legal benefits. For example, an independent contractor:
- Need not be covered by workers compensation insurance.
- Does not need to have any employment related taxes withheld from
their earnings.
- Has no right to participate in employee fringe benefit programs.
- Is not entitled to unemployment insurance benefits.
- Is not covered by various Federal (and possibly state) employment
regulations such as OSHA laws, minimum wage and hours laws, anti-discrimination
laws and the National Labor Relations Act.
Employers must use caution when making the classification. The IRS
and the state unemployment authority are very aggressive in this area
and the penalties for misclassifying workers are severe. Many employers
mistakenly believe that they can rely on one or two factors when making
the determination. Some of the more common single factors that employers
rely on are:
- The worker wanted to be treated as an independent contractor.
- The worker signed a written contract.
- The worker is paid sporadically or inconsistently or is only
paid on commission.
- The worker has no supervision.
- The worker performs services for more than one company.
Workers in certain professions are deemed to be independent contractors.
These professions include qualified real estate agents and direct sellers.
