There are a lot of reasons why businesses engage someone to provide a good or service as an independent contractor, including convenience and to save money. This is likely to happen especially when both sides anticipate a short engagement. Businesses get the benefit of the independent contractor’s knowledge and skill without having to worry about complying with employment laws.
Additionally, you do not have to provide the following for independent contractors:
- Match payroll taxes (federal and state taxes, unemployment, Social Security, and Medicare)
- Workers’ Compensation insurance
- Benefits
- Overtime Pay
As a result of this, the government loses money when employees are misclassified as independent contractors because those taxes are not being paid. So, the government has a great incentive to audit businesses and recover those missed wages.
Auditing employers on the classification of independent contractors and employees is currently one of the highest enforcement priorities of the federal government and there is no indication that this trend is likely to change. Since 2008, the Department of Labor has recovered hundreds of millions of dollars in back pay for unpaid overtime and minimum wage violations. No company seems to be exempt. Microsoft, FedEx, Walmart, and a countless number of small businesses have all been sued and audited over misclassification.
Engaging with an independent contractor has the potential to be a huge liability for any employer, so it is important to know how to classify them properly. In this discussion, we will explore what factors the government uses to determine who should be an employee and who should be a contractor.
How do you decide who is an employee and who is an Independent Contractor?
Well, the downside of this question is that there is no single answer to it. A government auditor or investigator will look at the “totality of circumstances” and make a decision based on the “economics realities” of the situation.
The government will ignore any written agreements between the business and the independent contractor that describe the relationships. Titles, job descriptions, and organizational charts are meaningless. Even in situations where the independent contractor had waived their right to be treated as an employee in a written contract, the contract was invalidated in court. The only factors they look at to make their determination are the “economic realities” of the relationship.
So what are these economic realities?
They are exactly what they sound like. How is the independent contractor paid and managed? Does the independent contractor have to report regularly on the progress of his work? What is the nature of the good or service the independent contractor provides? Is it different from those of the business?
When you break these economic realities down, there is a 20 Factor test to determine if someone is an employee or an independent contractor.
1. Instruction
A worker who is required to comply with instructions about when, where, and how work is to be done is ordinarily an employee
Contractors are not required to follow instructions to accomplish a job
2. Training
Training a worker indicates that the hiring firm wants the work done in a particular way
Contractors typically do not receive training by the hiring firm
3. Integration
Integration of the worker’s services into the business operations generally shows the worker is subject to direction and control
When the success or continuation of a business depends upon the performance of particular workers, those workers necessarily must be subject to a certain amount of control by the hiring firm
Contractors should not perform work that determines the success or continuation of the hiring firm
4. Services Rendered Personally
If the services must be rendered personally by the worker it is presumed that the hiring firm wants the work done in a particular way
Contractors usually have the right to hire others to do the actual work
5. Hiring, Supervising, and Paying Assistants
If the hiring firm hires, supervises, and pays assistants for a worker, that factor generally shows control over the worker
Contractors must have the authority to control their own assistants
6. Continuing Relationship
A continuing relationship between the worker and the hiring firm indicates that an employer-employee relationship exists
Contractors usually work for the hiring firm at irregular intervals, on call, or whenever work is available
7. Set Hours of Work
The establishment of set hours of work by the hiring firm is a factor indicating control over the worker
Contractors set their own hours of work
8. Full Time Required
If the worker must devote substantially full time to the business of the hiring firm, then the hiring firm controls the worker, and restricts the worker from doing other gainful work
Contractors should not be restricted from seeking and performing other gainful wor
9. Doing Work on Employer’s Premises
If the work is performed on the premises of the hiring firm, that factor suggests control over the worker, especially if the work could be done elsewhere
Contractors control where they work. If contractors perform work on the premises of the hiring firm, the firm should not direct or supervise their activities
10. Order or Sequence Set
If the hiring firm sets, or reserves the right to set, the order or sequence in which work is to be performed, that factor shows control over the worker
Contractors determine the order and sequence of their work
11. Oral or Written Reports
A requirement that the worker submit regular or written reports to the hiring firm indicates a degree of control
Contractors are hired to produce a final result, and therefore should not be required to submit interim reports
12. Payment by Hour, Week or Month
Payment by the hour, week or month generally points to an employer-employee relationship
Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor. Contractors may accept periodic payments based on a percentage of work completed, or some other fixed schedule determined before the job begins
13. Payment of Business and/or Traveling Expenses
If the hiring firm ordinarily pays 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
Contractors pay their own incidental expenses
14. Furnishing of Tools and Materials
The fact that the hiring firm furnishes significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship
Usually contractors furnish their own tools, materials, and other equipment. If the hiring firm provides such items, they should be leased to the contractor at fair market rate
15. Significant Investment
Lack of investment in separate facilities, such as maintenance or rental of one’s own office, indicates dependence on the hiring firm, and accordingly, the existence of an employer-employee relationship
Contractors should be able to do their work without using the hiring firm’s facilities. The contractor’s investment in their trade must be real, essential and adequate
16. Realization of Profit or Loss
Employees do not realize entrepreneurial profit, and are not at risk of loss as a result of their work
Contractors should be able to make a profit or suffer a loss as a result of their work
17. Working for More Than One Firm at a Time
The hiring firm may restrict its employees from working for another firm, such as a competitor, as a condition of employment
Contractors are not restricted from working for more than one firm at a time
18. Making Service Available to General Public
Employees work primarily for the hiring firm
Contractors make their services available to the general public on a regular & consistent basis
19. Right to Discharge
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
Employees have the right to terminate their relationship at any time without liability.
Contractors are responsible for the satisfactory completion of their contractual obligation, and may be subject to a penalty/legal action if they fail to complete the agreed upon work
If, after reviewing these factors, it is still unclear whether a worker is an employee or an independent contractor, you should consult with a human resources professional or an employment lawyer. Additionally, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The IRS will review the facts and circumstances and officially determine the worker’s status.
