Business owners must determine the type of workers they will utilize to
operate successfully. In some cases, owners think they are hiring independent
contractors but, in reality, those workers may actually be employees. Failure
to properly classify workers can result in fines, penalties, and payment of
back taxes, so it is important that business owners understand the legal
distinctions between an independent contractor and an employee.
I. Federal Law
Federal law provides that an employer/ employee relationship exists “when
the employee is subject to the will and control of the employer not only as to
what shall be done but how it shall be done.” 26 CFR §31.3401(c)-1. The determination of whether
an employer/ employee relationship exists will be “determined upon an
examination of the particular facts of each case.” Id. If the relationship is
truly that of employer/ employee, the parties’ description or characterization
of the relationship as that of an independent contractor is irrelevant. Id.
II. IRS’ 20 Factors
The Internal Revenue Service (“IRS”) has identified 20 factors to guide
business owners in determining whether a worker is an employee or independent
contractor. See IRS Ruling 87-41. The degree of importance of
each of these factors depends “on the occupation and the factual context in
which the services are performed.” Id. Employers should give special care in
analyzing the substance of the arrangement with their workers and consider
whether the employer exercises sufficient control over the worker to classify
that worker as an employee.
The factors set forth below are helpful in determining whether the worker
is an employee or an independent contractor. If answered in the affirmative,
these factors demonstrate the requisite control that supports an employer/
employee relationship.
1. Instructions: worker must comply with
instructions as to when, where, and how the work is to perform work.
1. Training: business owner provides
training to the worker by requiring an experienced worker to work with him or
her, and requiring the less-experienced worker to attend meetings.
1. Integration: integration of worker’s
services into the owner’s business operations.
1. Services Rendered Personally: services are rendered
personally by the worker (indicating business owner is interested in the
methods and results in accomplishing work).
1. Hiring, Supervising and Paying
Assistants: business owner has the right to hire, supervise and pay assistants.
1. Continuing Relationship: continuing relationship
between the worker and the person or persons for whom the services are
performed.
1. Set Hours of Work: the person for whom services
are provided sets the workers hours of work.
1. Full Time Required: the worker devotes
substantially full-time to the business for whom the services are performed,
and the person has control over the amount of time the worker spends working
and impliedly restricts the worker from doing other gainful work. An
independent contractor is free to work when and for whom he or she chooses.
1. Doing Work on Employer’s
Premises: the work is performed on the premises of the person for whom the services
are performed.
1. Order or Sequence Set: the worker is required to
follow the established routines and schedules of the person for whom the
services are performed.
1. Oral or Written Reports: the worker is required to
submit regular or written reports to the person for whom the services are
performed.
1. Payment: worker paid by the hour,
week or month. However, payment made by the job or straight commission
generally indicates an independent contractor arrangement.
1. Payment of Business and/or
Traveling Expenses: worker’s expenses paid for by another.
1. Furnishing of Tools and
Materials: provided by someone other than the worker.
1. Significant Investment: lack of worker investment in
facilities where the services are performed.
1. Realization of Profit or Loss: worker does cannot realize a
profit or loss as a result of his or her services.
1. Working for More than One Firm
at a Time: worker does not perform services for a multiple of unrelated firms at the
same time.
1. Making Service Available to
General Public: worker does not make his services available to the
general public on a regular and consistent basis.
1. Right to Discharge: worker can be discharged. An
independent contractor cannot be fired, so long as the independent contractor
produces a result that meets the contract specifications.
1. Termination: worker has the right to
terminate his or her relationship with the person for whom the services are
performed anytime.
III. Employment or Independent Contractor Agreement
In some cases, the business owner will execute an independent contractor
agreement with the worker thinking that, because of the title of the agreement
and because the business owner is not paying taxes on the worker, the parties
have such an independent contractor relationship. This approach is incorrect.
The employer should carefully analyze the factors set forth above, and
assuming the worker qualifies as an independent contractor, the agreement
should spell out the rights and obligations of the parties. The agreement
should also specify that the worker will not be treated as an employee for
federal tax purposes with respect to the services performed, and that the
worker is required and responsible for paying his or her own estimated income
tax payment, self-employed taxes, occupational taxes and other taxes, if any,
to the appropriate governmental entities. The agreement should also clarify
that the business owner will not withhold any taxes or compensation due to the
worker, nor provide workers’ compensation insurance. Finally, the agreement
should state the worker will not be provided any minimum salary, vacation pay,
sick leave or any other fringe benefit.
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