It is critical that the employer correctly determine whether an individual providing a service should be classified as an employee or independent contractor. This topic has undergone close scrutiny by the IRS due to its significant tax impact. Generally, an employer has to withhold and pay payroll taxes for an employee and does not have to withhold and pay payroll taxes for an independent contractor. There are specific individuals that are defined as employees or independent contractors by the Internal Revenue Code (IRC). For all others, there are 20 factors under common law tests that help determine the classification of a worker as an employee or independent contractor. All facts and circumstances for each individual must be carefully considered so that the appropriate classification can be made.
The IRC defines the following individuals as employees:
1. Officer of a corporation,
2. Agent-driver or commission-driver,
3. Full-time insurance salesman,
4. Home worker, and
5. Traveling or city salesman.
The IRC defines the following individuals as independent contractors:
1. Qualified, licensed real estate agents, and
2. Direct sellers.
For all other individuals that do not fit the above definitions of employees or independent contractors, the following 20 common law factors can be used to determine whether sufficient control exists for an employer-employee relationship.
1. Instructions: A worker that is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee.
2. Training: Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the employer wants the services performed in a particular method or manner.
3. Integration: When a worker’s services are integrated into the business operations this generally indicates that the worker is subject to direction and control.
4. Services Rendered Personally: If the services must be rendered personally, presumably the employer is interested in the methods used to accomplish the work as well as the results.
5. Hiring, Supervising, and Paying Assistants: If the employers hire, supervise, and pay assistants, that factor generally shows control over the workers on the job.
6. Continuing Relationship: A continuing relationship between the worker and employer indicates an employer-employee relationship exists.
7. Set Hours of Work: The establishment of set hours of work by the employer is a factor that indicates control.
8. Full Time Required: If the worker must devote substantial full time to the business, their employer has control over the amount of time the worker spends working; restricting the worker from doing other gainful work.
9. Doing Work on Employer’s Premises: If the work is performed on the premises of the employer, that factor suggests control over the work, especially if the work can be done elsewhere.
10. Order or Sequence Set: If a worker must perform services in the order or sequence set by the employer, that factor shows that the worker is not free to follow the worker’s own pattern of work but must follow established routines and schedules of the employer.
11. Oral or Written Reports: A requirement that the worker submit regular or written reports to their employer indicates a degree of control.
12. Payment by Hour, Week, Month: Payment by hour, week, or month generally points to an employer-employee relationship, provided this method is not a matter of convenience way of paying a lump sum agreed upon as the cost of a job.
13. Payment of Business and/or Traveling Expenses: If business and/or travel expenses are paid for by the employer, the worker is ordinarily an employee.
14. Furnishing of Tools and Materials: The fact that the employer furnishes significant tools, materials, and other equipment shows the existence of an employer-employee relationship.
15. Significant Investment: If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees, that factor tends to indicate an independent contractor.
16. Realization of Profit or Loss: A worker who can realize a profit or suffer a loss as a result of the worker’s services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor; such as if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees. The risk that a worker will not receive payments for his or her services does not constitute a sufficient economic risk to support as an independent contractor.
17. Working for More than One Firm at a Time: If a worker performs more than de minimus services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.
18. Making Service Available to General Public: The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
19. Right to Discharge: The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer.
20. Right to Terminate: If the worker has the right to end his or her relationship with their employer without incurring liability, that factor indicates an employer-employee relationship.
The 20 factors outlined above attempt to identify the extent of a business’s legal right to control how the worker performs the job. Again, the facts of each individual circumstance should be considered carefully.
Should you need additional information to determine whether a worker should be treated as an employee or independent contractor, please contact us.