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Employee vs. Independent Contractor

Tuesday, December 15, 2009

In times of economic uncertainty, some companies attempt to classify workers as independent contracts rather than employees so that the companies do not have to pay unemployment insurance, workers’ compensation, Social Security taxes, health insurance or retirement savings for these workers.  Worker-classification issues have existed for many years, but this problem surfaces more frequently in harder economic times.    

In Rev. Rul. 87-41, the IRS listed twenty factors that have traditionally been used to determine whether an individual is an employee or independent contractor.  These factors are:

    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.

    2. Training-the more training a worker receives, the more likely the worker is an employee.

    3. Integration-integration of the worker’s services into the business operations generally shows that the worker is subject to direction and control and is therefore more likely an employee.

    4. Services Rendered Personally-if the services must be rendered personally by the worker, the worker is more likely an employee.

    5. Hiring, Supervising and Paying Assistants-If an individual can hire, supervise and pay assistants, then the individual is more likely an employee.

    6. Continuing Relationship-a continuing relationship between the worker and the person for whom the services are performed indicates an employment relationship.

    7. Set Hours of Work-if the worker’s hours are set by the person for whom the services are performed, then the worker is more likely an employee.

    8. Full Time Required-if the worker devotes substantially full time to the business for which the services are performed, then it is more likely that the worker is an employee.

    9. Doing Work on Employer’s Premises-if the worker performs the work on the company’s situs, then this suggests an employer-employee relationship.

    10. Order or Sequence Set-if the worker must perform services in the order or sequence set by the person for whom the services are performed, then this suggests an employee relationship.

    11. Oral or Written Reports-if the worker must submit regular or written reports to the employer, this suggests an employee relationship.

    12. Payment by Hour, Week or Month-if the worker is paid hourly, weekly or monthly, this tends to suggest employee status.

    13. Payment of Business and Traveling Expenses-if the employer pays business and traveling expenses, then this suggests employee relationship.

    14. Furnishing of Tools and Materials-if the employer provides tools and materials, then this suggests employee status.

    15. Significant Investment-if the worker invests in facilities that are not typically maintained by employees, this suggests independent contractor status

    16. Realization of Profit or Loss-if the worker realizes a profit or loss as a result of the services, then the worker is generally an independent contractor.

    17. Working for More than One Firm at a Time-if the worker performs more than de minimis services for multiple unrelated persons, then the worker is generally an independent contractor.

    18. Making Service Available to General Public-if the worker makes his or her services available to the general public then the worker is generally an independent contractor.

    19. Right to Discharge-if the company maintains the right to discharge a worker, this suggests employee status.

    20. Right to Terminate-if the worker has the right to end the relationship without incurring any liability, then the worker is likely an employee.
 
Although the IRS cited to the twenty-factor test in Rev. Rul. 87-41, the IRS generally considers three major factors in making the determination.  These factors are behavioral control, financial control and the type of relationship.  Behavioral control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.  Financial control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.  The type of relationship factor relates to how the workers and business owner perceive their relationship.  In evaluating the three major factors, the IRS tends to bring up several of the twenty-factors. 

The IRS allows a taxpayer to use either the twenty-factor or the three-factor approach.  It seems that the common law twenty-factor formula may provide a greater insight into making this determination because this method provides more detailed information. 

This past summer, the IRS released Summertime Tax tip 2009-20 in which the IRS acknowledged that there was a major classification problem in the current economy.  This article discussed the top ten things that every business owner should know about hiring people as independent contractors versus hiring them as employees.  In addition to this article, the IRS has hinted that there will be more random audits of employers on the issue of worker classification. 

In order to avoid any worker classification issues, the IRS has an SS-8 form.  The purpose of this form is to allow workers and firms to request a determination of the status of a worker for purposes of federal employment taxes and income tax withholding.  There is no requirement that a fee be paid with this form.  In filling out this form, either the worker or the employer lists all of the key details of the relationship.  The IRS will then determine whether the worker is an employee or an independent contractor. 

If a worker is incorrectly classified and there is no reasonable basis for doing so, the IRS may hold the employer liable for all employment taxes for that worker retroactively or prospectively on a case-by-case basis. 

The status determination of a worker by a company is a very fact-intensive inquiry.  In making the determination as to whether a worker is an employee or an independent contractor, it will be necessary to make use of either the twenty-factor formula or the three-factor formula since both are accepted by the IRS. 

For more information on this issue, please contact:

• Jerome Reso
  reso@bhbmlaw.com
• Karl Zimmermann
  karlz@bhbmlaw.com
• John Rouchell
  rouchell@bhbmlaw.com
• Leon Rittengerg III
  leon3@bhbmlaw.com
• Kerry Hand
  hand@bhbmlaw.com
• Matthew Treuting
  treuting@bhbmlaw.com
• Jason Alley
  alley@bhbmlaw.com
• Matthew Miller
  miller@bhbmlaw.com