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Friday, May 25, 2007

Classification as an Independent Contractor or Employee

Let's face it, the distinction between an employee and an independent contractor has been and will remain a major focus of the IRS.
In its Revenue Ruling 87-41, 1987-1 C.B. 296, the IRS listed twenty factors or elements to consider in determining whether sufficient control is present to establish and employer-employee relationship. Following is a list of the twenty factors. It should be noted that not all the factors need be present to establish an employer/employee relationship. These factors are meant to be guides to determine the likelihood that a worker is an employee or an independent contractor.
The Twenty Factors:
  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 person or persons for whom the services are performed have the right to require compliance with instructions.
  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 person or persons for whom the services are performed want the services performed in a particular method or manner.
  3. Integration: Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
  4. Services Rendered Personally: If the Services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.
  5. Hiring, Supervising, and Paying Assistants: If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.
  6. Continuing Relationship: A continuing relationship between the worker and the person or persons for whom the services are performed 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 person or persons for whom the services are performed is a factor indicating control.
  8. Full Time Required: If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict 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 person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.
  10. Order of Sequence Set: If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the person or persons for whom the services are performed. Often, because of the nature of an occupation, the person or persons for whom the services are performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so.
  11. Oral or Written Reports: A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed 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 straight commission generally indicates that the worker is an independent contractor.
  13. Payment of Business and/or Traveling Expenses: If the person or persons for whom the services are performed ordinarily pay the worker's business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker's business activities.
  14. Furnishing of Tools and Materials: The fact that the person or persons for whom the services are performed furnish 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, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship. Special scrutiny is required with respect to certain types of facilities, such as home offices.
  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, but the worker who cannot is an employee. For example, 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, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risk to support treatment as an independent contractor.
  17. Working For More Than One Firm at a Time: If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
  18. Making Services Available to the 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. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. 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 his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer- employee relationship.

The IRS has a publication in the form of a brochure which summarizes many of the tax court findings in plain english. This Publication (#1779) looks at the many facts used by the tax courts and breaks them down into three main categories: behavioral control, financial control and relationship of the parties. The brochure stresses that every case is unique and it is important to consider all the facts.

Behavioral Control: A worker is an employee when the employer has the right to direct and control the worker. Note that the employer doesn't have to actually direct or control; merely have the right to do so. Examples given are Instructions and training. By receiving extensive instructions on how to do the work, the worker is likely deemed to be an employee. In the same way, if the employer provides training as to procedures and methods for doing work; this also suggests that the worker is an employee.

Financial Control: Having a significant investment in your work, you may be deemed an independent contractor. The brochure doesn't define significant investment, but I imagine it would mean, for example, lawn care person providing mowers and such to do lawn work. A worker may also be deemed and independent contractor if they are not reimbursed for business expenses. Finally, the recognition of a profit or loss signifies that you are in business for yourself and thus an independent contractor.

Relationship of the Parties: Receiving benefits (insurance, pension, vacation pay, etc.) is a good indicator that the worker is an employee.

Follow this link for an interesting article on the subject: CFO.com: Employers Hit for Misclassifying Workers

3 comments:

AccountingHelpDesk said...

This is a real issue and a hot topic for the IRS. Whether you are a small business or a large corporation; tread carefully when classifying someone as an independent contractor.

Anonymous said...

It’s funny to find out just how many different sites the internet has on this matter. :)

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