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Is Your Worker an Employee or Independent Contractor?
An ongoing issue for a business is whether its workers are employees or independent contractors. If workers are employees, the business must withhold federal and state income taxes and social security taxes on the wages it pays. It must also pay federal and state unemployment taxes. It may also have to provide fringe benefits and retirement plan coverage. However, none of these responsibilities apply to independent contractors.
IRS Revenue Ruling 87-41 contains 20 factors used to determine if a worker is an employee or an independent contractor. These factors are known as the common law rules. They are indicators as to whether sufficient control exists to create an employer-employee relationship. The 20 factors are as follows:
1. Instructions. A worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the business has the right to make the worker follow instructions.
2. Training. Training a worker by requiring an experienced employee to work with the worker, by requiring the worker to attend meetings, or by using other methods, indicates the business wants the services performed in a particular method or manner. Ongoing training is a strong sign of an employer-employee relationship.
3. Integration. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control.
4. Services Rendered Personally. If the services must be rendered personally, the business probably is interested in the methods used to accomplish the work as well as in the results.
5. Hiring, Supervising, and Paying Assistants. A business that hires, supervises, and pays assistants for a worker is exhibiting employer type control. However, if the worker hires, supervises, and pays assistants, an independent contractor relationship is indicated.
6. Continuing Relationship. A continuing relationship between the worker and the business indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring, although irregular, intervals.
7. Set Hours of Work. The establishment of set hours of work by the business is a factor indicating control.
8. Full Time Required. If the worker must devote substantially full time to the business, the business has control over the amount of time the worker spends working and impliedly restricts the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
9. Doing Work on Employer's Premises. If the work is performed on the premises of the business, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises, such as at the worker's office, indicates some freedom from control. The importance of this factor depends on the type of services involved and whether an employer generally requires employees to do similar work on its premises.
10. Order or Sequence Set. A business exhibits control over a worker if it requires him or her to perform services in a specific order or sequence.
11. Oral or Written Reports. A requirement that the worker submit regular or written reports indicates a degree of control.
12. Payment by Hour, Week, Month. Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
13. Payment of Business and/or Traveling Expenses. If the business ordinarily pays the worker's business and/or traveling expenses, the worker is ordinarily an employee.
14. Furnishing of Tools and Materials. The fact that the business supplies the worker with significant tools, materials, and other equipment tends to show 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 (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, if the worker depends on the business to provide the facilities, an employer-employee relationship is indicated.
16. Realization of Profit or Loss. A worker who can realize a profit or suffer a loss from their services generally is an independent contractor, but one who can't is an employee.
17. Working for More Than One Firm at a Time. If a worker performs more than de minimis services for multiple unrelated businesses 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. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
20. Right to Terminate. If the worker has the right to end their relationship with the business at any time without incurring liability, that factor indicates an employer-employee relationship.
These factors can be confusing and there is no steadfast rule on how many must be satisfied. If you have any questions or wish to discuss if your workers are being classified properly, please contact MKS&H's Senior Tax Accountant, Tony Dulo, at 410-296-6200.