Last week, we ventured into the scary territory of worker (mis)classification. (Click here to review). We now know that classifying someone as an independent contractor just so we can avoid paying minimum wage, offering benefits, absorbing administrative costs and complying with laws that often feel onerous may be illegal and may land an employer in more hot water than s/he is seeking to avoid in the first place. How do we know if we have correctly classified our workers? That is this week’s topic, which follows after the jump…
Proper classification of workers must be made on a case-by-case basis, considering all relevant facts and circumstances. The IRS and various state tax agencies rely on common law rules as well as a list of 20 factors that its auditors use as guidelines in determining whether a worker is an employee or independent contractor. Space does not permit discussion of how each State deals with this issue, so this post will focus on the IRS criteria.Under common law rules, workers are employees if the hiring party has the right to direct and control them in the way they work, including final results and details of when, where and how the work is done. Generally speaking, the IRS will look at three categories of control in order to determine if there is sufficient control to warrant classifying the workers as employees. The three categories are:
- Behavioral Control – do you have the right to control how your worker performs a specific task? Yes? Your worker may be an employee then.
- Financial Control – If you direct or control how the worker conducts the business aspects of his/her/their activities, such as unreimbursed expenses, opportunity for profit or loss, method of payment, significant investment and availability of services to the market you may have hired an employee.
- Relationship of the parties: How do you and your worker(s) perceive your relationship? Employee benefits, written contracts, discharge and termination aspects and your regular business activity are some indicators considered.
Note that whether any one of the above factors is more or less important than the others will depend on the type of work being done, and the hiring party’s particular circumstances. Analysis based on control can be very subjective. This means that an IRS or State auditor may find it very easy to disagree with your analysis. What should you do then? Ideally, you will want to make a brutally honest assessment of how great a risk you are taking if you classify your workers as independent contractors. Can you handle the likely consequences if the IRS concludes that your workers are really employees? If not, err on the side of caution and classify your workers as employees. A tax professional or employment attorney can help you make that determination. The IRS will also, on request, provide you with a determination. (The key is to ask for it before an auditor comes knocking, though).
The IRS has also published a list of 20 factors that its auditors use as guidelines to make a proper determination. These factors, in general, are more objective than the above common law behavioral categories. So, without further ado, here are the “Big Twenty”:
- Instructions: If workers must comply with your instructions as to when, where and how to work they are probably employees.
- Training: If you provide or in the past provided training to workers, they are probably employees. Why? Independent contractors are supposed to know how to do their work and therefore shouldn’t need training from someone purchasing their services.
- Integration: The more integral your worker’s services are to your business’ success, the more likely the workers performing those services are employees.
- Services rendered personally: Must a particular worker or group of worker personally perform the services in question, or does the worker or group of workers have the right to substitute other people’s services for their own in fulfillment of a contract? If the former, then they are probably employees, if the latter they are probably independent contractors.
- Hiring Assistants: Are your workers in charge of hiring, supervising and paying their own assistants? If yes then they are probably independent contractors. If no, they are probably employees.
- Continuing Relationship: The longer the time period or the more recurring intervals during which services are performed, the more it will appear to be an employer-employee relationship (remember this is one factor only and by itself will not necessarily determine the classification. I reserve the right to come back to this particular point in a later post.)
- Set Hours of Work: If workers can set their own hours there is a greater change of them being independent contractors? If you establish set hours of work for them, they are more likely to be considered employees.
- Full-time: Independent contractors usually can work whenever and for whomever they want. In contrast, if you require them to be available full-time, they will more likely be considered your employees.
- Work done on premises: If workers must work on your premises or a place designated by you, they are more likely employees. Independent contractors usually have their own place of business where they can do their work for you.
- Set Order or Sequence: If you setting the order or sequence in which workers perform the services in question, the IRS will more likely see those workers as employees.
- Reports: If you require your workers to submit reports to you, then your relationship is more likely one of employer-employee.
- Payment Method: Workers paid by the job are more likely independent contractors; those paid by week or month are more often seen as employees. (Hourly pay, in my humble opinion may not determine status by itself, but will probably have to be considered along with the other 19 factors.)
- Expenses: Most independent contractors are expected to cover their own overhead expenses (in the absence of a contrary contractual arrangement);workers whose business and travel expenses you pay are more likely to be employees.
- Tools and materials: Independent contractors usually supply their own tools, materials and equipment, whereas those using your tools, equipment, etc., are more likely your employees.
- Investment: The greater your workers’ investment in materials they use to do their work, the more likely they can be classified as independent contractors.
- Profit or Loss: The greater the risk that workers can either make a profit or suffer a loss in doing their work, the greater chance of them being classified as independent contractors.
- Works for more than one person/entity at a time: The more entities your worker(s) work for at any one time the more likely s/he/they are independent contractors. If s/he/they work only for you, that scenario lends itself more to an employee classification.
- Services available to the general public: (e.g. through business cards, ads, promotional items) likely render the person(s) performing them to be independent contractors.
- Right to fire: Workers you can fire at any time are more likely employees. The right to terminate independent contractors however, is usually limited by specific contractual terms.
- Right to quit: Workers who can quit at any time without any risk of liability are probably employees (they have less investment and less control). Independent contractors cannot usually walk away in the middle of a project without being financially accountable.
You may have noticed two common threads in all 20 factors: your ability to control versus the worker’s independence and the extent of your worker’s investment and exposure to risk of loss. The more control you exercise, the more likely your workers are employees. The more your workers control their work, the more they incur the risk of incurring profit or loss or financial liability the more likely they are independent contractors.
Wait: doesn’t the IRS have a “safe harbor” and an “amnesty” program? Yes they do. We’ll tackle those in the next post. Have a great weekend!
Disclaimer: Contents of this post are for informational purposes only, are not legal advice and do not create an attorney-client relationship. Always consult with competent local employment counsel on any issues discussed here.
Click here to learn more about Janette Levey Frisch, author of The Emplawyerologist.
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