Employers – be careful in classifying workers! The difference between an “employee” and an “independent contractor” is critical. As employers know, if the worker is an “independent contractor” the benefits are many: no payroll taxes, no employee benefits, no workers compensation insurance, no medical insurance worries, etc. That is fine as long as the worker is truly an independent contractor and NOT an employee. But, if an IRS audit classifies that worker as an employee instead of an independent contractor, YOU (the employer) are responsible for back payroll taxes, penalties, and interest. YOU may also be responsible for the employee’s portion of payroll taxes and even his income taxes if he did not report the income and the IRS cannot collect from the employee.
Generally, a worker is an “employee” for federal employment tax purposes if an “employer-employee relationship” exists under the usual common law rules. Generally, that relationship exists when the person for whom the services are performed has the right to control and direct the individual who performs the services; not only as to WHAT he or she does, but HOW he does it. That is, an “employee” is subject to the will and control of the employer. The employer does not have to actually direct or control the manner of services, it is sufficient that the employer has the right to do so.
Conversely, a worker is generally NOT an “employee” if he or she follows an independent trade, business, or profession, in which he offers his services to the public (such as physicians, lawyers, dentists, contractors, and subcontractors.) They would generally be considered “independent contractors”.
To aid in determining the status of a worker, twenty factors have been identified as indicating whether sufficient control is present to establish an employer-employee relationship. These twenty factors have been developed, as a guide, by our tax service, CCH, based on an examination of cases and rulings. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed. The twenty factors are described below:
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. 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.
4. Services Rendered Personally. If the services must be rendered personally instead of by a designee of the person contracted, this indicates an employee status.
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.
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.
10. Order or 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.
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 a 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.
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.
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.
17. Working for More Than One Firm at a Time. If a worker performs more than de minimus services for a multiple of unrelated persons or firms 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 and the person possessing the right is an employer. 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.
For more information, you may want to read what the IRS has to say on the subject. The following two links provide such information.
For the IRS “fact sheet” click here: https://www.irs.gov/newsroom/understanding-employee-vs-contractor-designation
For additional IRS information, and some scenarios that may apply to you, click here: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
Feel free to contact us at 714.672.0022 with any questions. Here at LSL, our main priority is to help you succeed.
This article submitted by Susan F. Matz, CPA, Tax Partner and David Hale, CPA, Retired Tax Partner with Lance, Soll & Lunghard, LLP.
Employee vs Independent Contractor PDF
