SOURCE: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

 

Most employers “prefer” to classify the people they pay for services performed for the business as INDEPENDENT CONTRACTORS to avoid paying payroll taxes, worker’s compensation, and/or some employee benefits they would have to otherwise pay of they classify them as employees instead.  It is also much easier to just pay them regular checks rather than paychecks with tax withholdings, etc… However, this is not really a choice or preference.  There are strict rules that most be followed in order to make sure this can be done.

Employers most prove (with evidence) that if they classify the person as Independent Contractor, they are truly independent and that the employer did not have control over the contractor/employee.  There are grouped into 3 categories:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

    Behavioral control refers to facts that show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.

    The behavioral control factors fall into the categories of:

    • Type of instructions given
    • Degree of instruction
    • Evaluation systems
    • Training

    Types of Instructions Given

    An employee is generally subject to the business’s instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work.

    • When and where to do the work.
    • What tools or equipment to use.
    • What workers to hire or to assist with the work.
    • Where to purchase supplies and services.
    • What work must be performed by a specified individual.
    • What order or sequence to follow when performing the work.

    Degree of Instruction

    Degree of Instruction means that the more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee.  Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.

    Note: The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up that right.

    Evaluation System

    If an evaluation system measures the details of how the work is performed, then these factors would point to an employee.

    If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.

    Training

    If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way.  This is strong evidence that the worker is an employee. Periodic or on-going training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.

  • Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.).

    Financial control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job.

    The financial control factors fall into the categories of:

    • Significant investment
    • Unreimbursed expenses
    • Opportunity for profit or loss
    • Services available to the market
    • Method of payment

    Significant investment

    An independent contractor often has a significant investment in the equipment he or she uses in working for someone else.  However, in many occupations, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment.  Furthermore, a significant investment is not necessary for independent contractor status as some types of work simply do not require large expenditures.

    Unreimbursed expenses

    Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform for their business.

    Opportunity for profit or loss

    The opportunity to make a profit or loss is another important factor.  If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money (i.e., their expenses will exceed their income from the work).  Having the possibility of incurring a loss indicates that the worker is an independent contractor.

    Services available to the market

    An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.

    Method of payment

    An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly

  • Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

    Type of relationship refers to facts that show how the worker and business perceive their relationship to each other.

    The factors, for the type of relationship between two parties, generally fall into the categories of:

    • Written contracts
    • Employee benefits
    • Permanency of the relationship
    • Services provided as key activity of the business

    Written Contracts

    Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status.  The IRS is not required to follow a contract stating that the worker is an independent contractor, responsible for paying his or her own self employment tax.  How the parties work together determines whether the worker is an employee or an independent contractor.

    Employee Benefits

    Employee benefits include things like insurance, pension plans, paid vacation, sick days, and disability insurance.  Businesses generally do not grant these benefits to independent contractors.  However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor.

    Permanency of the Relationship

    If you hire a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.

    Services Provided as Key Activity of the Business

    If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities.  For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work.  This would indicate an employer-employee relationship.

There is no magic formula to figuring this our, but it is important to know is what the IRS uses to test the level of control and independence, which is the form SS-8
https://www.irs.gov/pub/irs-pdf/fss8.pdf

There are over 50 questions that the contractor has to answer, and based on those answers, the IRS may determine to reclassify the contractors to employees, which will cause BIG PENALTIES, consult your CPA or Tax Attorney if you are unsure.

 

 

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