Nearly every business needs to hire or contract with other businesses or individuals to provide services in the course of running the business. In doing so, the owners and managers have a duty to determine if the individuals are employees or independent contractors. This decision-making process can often be ongoing. Further, making the right decision is always crucial because of the responsibilities that come with an employer-employee relationship, and the consequences of improper classification can carry significant tax lawyer or request an IRS determination. The consequences of an improper categorization can be severe.
The IRS uses the following list of 20 factors to assist in the making of a determination between employee or independent contractor status:
- Profit and Loss: Here the IRS looks at whether or not a worker incurs a profit or loss as a result of the work they conduct. Do the worker’s circumstances indicate that they are taking an economic risk? Do they have the opportunities to benefit from the association with the business besides wages? The more exposure to risk a worker has, the more likely they are to be considered an independent contractor by the IRS.
- Investment: Here the IRS will ask if the worker owns their own equipment, or if they have access to the facilities required to complete their work without the supervision of the business? The more the worker has invested in their own equipment, training, and certification, the more likely the IRS will agree to their independent contractor status.
- Exclusivity of employment: Here the IRS will look at whether the worker provides services exclusively for the business in question. Does the worker have the freedom to work for other companies? Is the a non-compete clause in the worker’s contract? The more freedom and autonomy a worker has, the more likely they are to be considered an independent contractor by the IRS.
- The General Public: This factor is similar to #3, however rather than other companies this factor deals with the worker’s ability to market his services to other businesses. The IRS will ask if the worker can offer services direct to the general public? Does the worker engage in marketing activities or otherwise advertise him/herself?
- Instructions: Does the business’s owner or management tell the worker how, when and where they must perform the work? Or does the worker decide these things on his/her own? Again, the more freedom and autonomy a worker has, the more likely they are to be considered an independent contractor by the IRS.
- Training: Does worker to perform their job in a particular way, pursuant to training provided by the business? To whatever extent the worker takes advanced learning or continuing education courses, who pays for it? Who decides which courses the worker takes? The more responsibility a worker has for maintaining any certifications or licenses required to offer their services, the more likely they are to be considered an independent contractor by the IRS.
- Integration: Is the worker an integral part of the business? Are they necessary to the operation of the business? If the worker was to stop providing services to the business, how would the business go about replacing those services? The more integral a worker is to the business, the more likely they are to be considered an employee by the IRS.
- Services Rendered Personally: Is it necessary for the worker to personally deliver the services? Or is the worker free to delegate the work to other people that they employ?
- Hiring & Termination of Subordinates or Assistants: Does the company or the worker have control over the hiring, training, paying and termination over any assistants for the worker? Or does the worker make these decisions independently?
- Continuing Relationship: Is there an ongoing relationship between the business and the worker? Are contracts between the business and the employer open-ended, or do they offer a defined end point? The more limited the scope of engagement is between the two parties, the more likely the worker is to be considered an independent contractor by the IRS.
- Work Hours: Who sets the work hours in which services are performed? The worker or the business? The more autonomy a worker has over his/her hours, the more likely they are to be considered an independent contractor by the IRS.
- Full-Time Work: This factor is also similar to Exclusivity of Work. But here the IRS will ask if the worker must spend all of their work time performing tasks for the business in question, or if they have the ability to seek out other opportunities.
- Work Performed On Premises: Who decides where the work must be performed? The worker or the business?
- Sequence: Who has the right to control the order in which the worker delivers services? The worker or the business?
- Reports: Must the worker provide the business with reports accounting for their actions? How much supervision of the work is conducted by the business owners or management?
- Pay Schedules: How frequently and regularly does the business pay the worker? Does the worker have a fixed salary which is paid on a regular schedule by hour, week or month? Or does the worker submit invoices as the work is performed? The more structured the compensation structure, the more likely a worker is to be considered an employee by the IRS.
- Expenses: Who pays the business or travel expenses incurred in performance of the worker’s duties? The worker or the business? The more responsibility a worker has for these expenses, the more likely they are to be considered an independent contractor.
- Tools and Materials: This factor is similar to #2. Here the IRS will ask who provides the worker with the equipment, tools and materials necessary to perform their tasks?
- Right To Fire: Who makes a decision to terminate the business relationship with the worker? What would go into the decision-making process, and the execution of the decision? The more difficult it would be for a business to terminate the relationship, the more likely the worker is to be considered an employee.
- Right To Quit: Here the IRS will look at whether or not the worker has the freedom to cease offering services at anytime without incurring further liability? The more difficult it would be for the worker to terminate the relationship, the more likely the worker is to be considered an employee.
Businesses must examine all 20 factors when determining whether a worker is an employee or independent contractor, as the IRS will. The decision will often require a balancing of factors, as some may lean towards classification as an employee, while others will indicate that the worker is an independent contractor. The weight given to each factor will vary from situation to situation, and it will be the “big picture” that ultimately decides the issue. The IRS considers improper classification of an employee as an independent contractor to be an area of significant noncompliance. If you are undergoing an IRS audit involving worker classification issues, or anticipate that an IRS audit may be on the horizon, it is wise to retain experienced legal counsel and take great caution in how you respond to the IRS.
Don’t Delay, Consult The Tax Lawyer
William D Hartsock, Esq has been successfully helping clients resolve business tax issues and payroll tax matters since the early 1980's. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule a free consultation with a tax attorney simply fill out the contact form found on this page, or call (858)481-4844.