Soothsayer: Aye, Caesar, but not gone.
—Julius Caesar, Act III, Scene 1
On this March 15th, human-owned businesses don’t need Shakespeare’s Soothsayer to warn of forthcoming trouble in the classification of employees and independent contractors, the Federal budget does that for us. A joint enforcement effort by the Treasury Department (home of the IRS) and the Labor Department (home of the Wage and Hour Division, enforcers of the Fair Labor Standards Act) to reclassify independent contractors as employees is projected to add at least $7 billion to the government’s bottom line over the next ten years.
Business and government have wrestled over the proper classification of workers as employees or independent contractors for years. Why? The New York Times, in an article citing reports of almost one in three businesses misclassifying employees as contractors, summed up the stakes this way:
Companies that pass off employees as independent contractors avoid paying Social Security, Medicare and unemployment insurance taxes for those workers. Companies do not withhold income taxes from contractors’ paychecks, and several studies have indicated that, on average, misclassified independent workers do not report 30 percent of their income.Some businesses intentionally misclassify workers. In the process, they take advantage of those workers, gain an unfair advantage on companies playing by the rules, and increase the tax burden on everyone. Many more businesses, however, are victims of the subjective nature of worker classification.
You see, there is no clear definition of “employee” in the Internal Revenue Code. Instead, we are told to use traditional legal concepts involving control of the worker in order to distinguish employees from nonemployees. The IRS developed a list of 20 factors to aid in classification inquiries. For those who love details, those 20 factors are included after the jump at the end of this post; for the rest of you and for business owners generally, the IRS boiled-down the 20 factors into three categories for proper worker classification:
- Behavioral: If the business has the right to control only the result of the work, then the factor indicates a contractor. If the business has the right to control how the work is done, then the factor indicates an employee.
- Financial: If the worker risks losing money doing the work, the factor indicates a contractor. If expenses of the work and the tools and supplies needed are provided by the business, the factor indicates an employee.
- Type of Relationship: The existence of a contract and what it calls the relationship isn’t generally a factor, but please don’t claim a worker as a contractor when he or she has an “employment” contract with you. Beyond that, the presence of employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.) indicates employment, but the absence of benefits doesn’t mean the worker is a contractor. Long relationships and work that is the key to the business of the employer indicate employee status.
If you have either of those two facts against you or if you have questions about the application of these factors in your business, then you could become part of that additional $7 billion in revenue the government is counting on from this effort. See me or your lawyer to review your situation before that happens.
The Twenty Factors Used by the IRS
From Revenue Ruling 87-41 issued by the IRS in 1987
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. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
4. Services Rendered Personally. If the services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.
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. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.
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.. Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.
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. Often, because of the nature of an occupation, the person or persons for whom the services are performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so.
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. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker's business activities.
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. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship. Special scrutiny is required with respect to certain types of facilities, such as home offices.
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. For example, if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risk to support treatment as an independent contractor.
17. Working for More Than One Firm at a Time. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
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 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. 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.