Employee or Independent Contractor: What are the rules?
You have hired an individual to perform services for you or your company. So how do you know if that person is now your employee or is an independent contractor?
Generally an employer-employee relationship arises when the person for whom services are being performed has the right to control and direct the individual who performs the services, not only as to the result of the work being performed but also as to the details of the work being performed. The term employee has been defined for purposes of Social Security and Medicare Tax withholding and Federal Unemployment Tax.
For these purposes, an employee is defined in Internal Revenue Code section 3121(d). The section generally defines an employee as an “individual who, under usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” Common law rules are generally English law rules derived from custom and judicial precedent rather than statutes.
The IRS usually classifies workers as employees whenever their status is not clear-cut. So it is important that employers make certain that the person they are hiring is clearly not an employee. The IRS uses a 20 part test (published in 1976) in defining independent contractors, with no one particular part having greater weight than any other part. Because of the changing business environment since the time of publication, some of the 20 part test items are no longer applicable or have changed in terms of their application to the employer-employee scenario.
1. Level of instruction. If the company directs when, where, and how work is done, this control indicates a possible employment relationship.
2. Amount of training. Requesting workers to undergo company-provided training suggests an employment relationship.
3. Degree of business integration. Workers whose services are integrated into business operations or significantly affect business success are likely to be considered employees.
4. Extent of personal services. Companies that insist on a particular person performing the work indicate a possible employment relationship.
5. Control of assistants. If a company hires, supervises, and pays a worker’s assistants, this control indicates a possible employment relationship.
6. Continuity of relationship. A continuous relationship between a company and a worker may indicate a possible employment relationship.
7. Flexibility of schedule. People whose hours or days of work are dictated by a company likely will qualify as employees.
8. 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.
9. Need for on-site services. Requiring someone to work on company premises if the work may be performed elsewhere may support an employment relationship.
10. Sequence of work. If a company requires work to be performed in specific order or sequence, this control suggests an employment relationship.
11. 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.
12. Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of employment relationships.
13. Payment of business or travel expense. Direct reimbursement of travel and other business costs by a company may suggest an employment relationship.
14. 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.
15. Investment in facilities. Independent contractors typically invest in and maintain their own work facilities.
16. 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.
17. Work for multiple companies. People who simultaneously provide services for several unrelated companies are likely to qualify as independent contractors.
18. Availability to public. If a worker regularly makes services available to the general public, this supports an independent contractor determination.
19. 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.
20. 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.
In IRS Publication 15-A, Employer’s Supplemental Tax Guide, the IRS provides additional order and guidance to the classification of an individual as an employee or as an independent contractor. Effective January 1, 2020, the IRS will “group” factors into three general categories. While the “20 part” test remains valid, those factors have been compressed into three areas. The three areas are behavioral control, financial control, and relationship of the parties.
Behavioral control includes facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired. These facts include the control of when and where to do the work, whose tools or equipment are used, specific duties assigned, instructions given, and training that the business gives to the worker.
Financial control includes facts that show whether the business has a right to control the business aspect of the worker’s job. These include who pays unreimbursed business expenses, the extent of the worker’s investment in facilities and tools used, the extent the worker makes services available in the market, the manner in which the worker is paid and the extent to which the worker realizes profit or loss.
Facts that show the relationship of the parties include existence and terms of a written contract, provision of benefits to the worker and the permanency of the relationship.
The issue of determining independent contractor status versus employment status is a complex issue. Contact your Stanfield + O’Dell tax professional with any questions you have regarding this issue or any other tax issues.