The determination of whether a worker should be treated as an employee or an independent contractor is a complex issue. There is often no clear-cut answer to the question. Tax law follows the “20 Question” test of common law. However, there is no specific number of right or wrong answers. The stakes can be very high.
Reclassification of a worker from an independent contractor to employee can cause significant problems for an employer. The employer may be subject to unpaid payroll taxes and this may even cause a personal liability for the business owners and others. The monetary penalties involved can also be very severe.
It was enough of a concern when it was the IRS looking at the worker classification issue. Now, for the first time, the Department of Labor has audited a business and challenged worker classification. This opens a whole new door for worker classification problems. At this time it is unclear how aggressively the Department of Labor will proceed in auditing
businesses for worker classification.
Because of the potential severity of the results of misclassifying workers, we strongly suggest that any business that may have classified workers as independent contractors when they could be considered employees discuss the situation with a qualified tax advisor or attorney who can draft agreements that can aid in classifying your contractors.
To aid you in determining if you might have a worker classification issue, below are the twenty questions which the IRS uses to determine classification. Most of these issues are subjective in nature and there is no clear-cut answer to these questions. Each situation is judged on its own facts and circumstances. Unfortunately, the IRS and the Department of
Labor is making the initial determination if a businesses classification is appropriate.
Following is the list of the twenty 20 questions:
- Instructions and Procedures. A sub-contractor who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with specific instructions.
- Training/Assisting. Training a sub-contractor by requiring an experienced employee to work with the sub-contractor, by requiring the sub-contractor to attend meetings, or by using other means of communication, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner.
- 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.
- Hiring and Supervising Assistants. If the company for whom the services are performed hire and supervise assistants, that factor generally shows control over the workers on the job. However, if one worker hires and pays the other assistants pursuant to a contract under which the worker agrees to provide services and under which the worker is responsible only for the attainment of a result, this point usually indicates independent contractor status. In other words, if the contractor actual hires their own staff/contractors.
- Ongoing Relationship. A continuing relationship between the worker and the subcontractor 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. This issue really depends on the particular industry that the company is in.
- Work Done Personally. If the services must be rendered personally, then they may assume that the persons are employees.
- Set Hours of Work. An established of set hours of work by the person or persons for whom the services are performed is a factor indicating control and this may lead to reclassification to an employee.
- Substantial 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 restriction on the worker from doing other gainful work is implied. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
- Performance of Work on Employer’s Premises. If the work is performed on the premises of the Employer for whom the services are performed, that factor suggests control over the Subcontractor, especially if the work could be done elsewhere. Work done off the premises of the person or persons receiving the services 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.
- Order of events. If a subcontractor must perform services in the order or sequence set by the employer 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.
- Compensation/Payment Rate. Payment by the hour, week, or month usually 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 subcontractor is an independent sub-contractor.
- Type of Reporting. 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 and potential reclassification.
- Reimbursement of Business and/or Traveling Expenses. If the employer ordinarily pays the sub-contractor’s business and/or traveling expenses, the worker is usually an employee.
- Furnishing of Equipment and Materials. The fact that the employer furnishes significant equipment and materials tends to show the existence of an employer-employee relationship.
- Maintenance of Independent office. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as a rented office), 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.
- Working for One Firm. A worker who performs services for more than one person may be an employee of each of the person, especially where such persons are part of the same service arrangement. However if a sub-contractor performs more than the minimum services for a multiple of unrelated persons or firms, at the same time, this generally indicates that the worker is an independent contractor.
- Realization of Profit or Loss. A worker who can realize a profit or a loss as a result of the worker’s services 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.
- Making Service Available to General Public. The fact that a sub-contractor makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship. This is one of the strongest points in this list, that usually help in beating any claims by the IRS agent.
- Right to Discharge. The right to discharge a subcontractor 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 agreement requirements.
- Right to Terminate the Relationship. If the sub-contractor 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
Written By: G.F. Joey Musmar, CPA, CVA
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