During the last few years, more and more companies have resorted to utilizing independent contractors to help them get the work done. However, when using independent contractors, companies need to structure the work carefully to avoid creating an official employment relationship.
Independent contractors do relieve employers of many legal compliance issues to include: eliminating the employee count towards determining employer coverage under most federal employment statutes; elimination of the obligation to pay federal and state unemployment insurance, Social Security, and Medicare taxes; elimination of employee protections under the Fair Labor Standards Act, ERISA, the Family and Medical Leave Act, the National Labor Relations Act, and federal nondiscrimination statutes; and elimination of state workers’ compensation premiums. However, improperly classifying employees as independent contractors may carry substantial penalties. Employers need to make sure that an independent contractor truly meets the factors for that status.
The Internal Review Service (IRS) examines factors, derived from common law rules, to determine whether a worker qualifies as an independent contractor or an employee for the purposes of federal income, Social Security, Medicare, and unemployment taxes. The facts that provide evidence of the degree of control and independence fall into three categories: behavioral; financial; and type of partnership. The more control a company exercises over how, when, where, and by whom the work is performed, the more likely the workers are employees. Independent contractors control the manner and means by which services, products, or results are achieved.
Behavioral/Financial/Type of Relationship Factors –
1. Types of instruction. If the company directs when, where, and how the work is to be completed, this may indicate an employment relationship. Ask yourself:
- When and where will the employee do the work?
- What tools or equipment will they use to do the work?
- Who will make the decision on what workers to hire or to assist with the work?
- Where will the worker purchase supplies and services?
- What work must be performed by a specific individual?
- What order or sequence will the worker follow when performing the work?
2. Degree of instruction. The more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee.
3. Amount of training. Mandatory company-provided training for workers on how to do the job strongly suggests an employment relationship.
4. Evaluation of work. If an evaluation system measures the details of how the work is performed, then these factors point to an employment relationship.
5. Significant investment in equipment or supplies. There are no precise dollar limits that must be met in order to have a significant investment difference between an employee and an independent contractor.
6. Payment of business or travel expenses. Direct reimbursement of business or travel expenses generally indicates an independent contractor. However, employees may also have unreimbursed expenses in connection with the services that they perform in their business.
7. Realization of profit or loss. If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money. Having the possibility of incurring a loss indicates that the worker is an independent contractor.
8. Services available to the market. An independent contractor is generally free to seek out business opportunities with several unrelated companies. They often advertise, maintain a visible business location, and are available to work in the relevant market.
9. Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of employment relationships. Commissions or payment at the end of a project are typically consistent with independent contractors.
10. Services provided as a key activity of the business. If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities and this implies an employment relationship.
11. Continuity of relationship. Continuous relationships between the company and a worker indicate an employment relationship.
12. Control over discharge. Independent contractors generally work under a contract that includes terms for termination. An employer’s right to terminate a worker suggests an employment relationship.
When determining if a worker is an employee or independent contractor, remember that a worker does not have to meet all of the factors to qualify as one or the other. No single factor is used for determining a worker’s status. The individual circumstances of each case determine the weight that the IRS assigns different factors. Employers uncertain about how to classify a worker can request a determination from the IRS. The Form SS-8, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding” can be found at www.irs.gov/pub/irs-pdf/fss9.pdf. However, as with anything, employers are cautioned that the IRS usually classifies workers as employees whenever their status is not clear. In addition, employers who request the determination lose certain protections against liability for misclassifications.
For additional information on whether workers are independent contractors or employees, please contact
New Focus HR.
Written By: Kristen Shingleton, M.B.A., CCP
President, New Focus HR LLC