Whether a worker is an employee or independent contractor depends on the right or ability of a company to exercise control over the worker.
An 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. In contrast an independent contractor (contractor) is engaged to provide a finished project or job. The way in which it’s completed is left to the discretion of the contractor.
Common factors considered
The IRS and the courts often decide worker classification cases by reviewing three categories of evidence as to whether a worker is an employee or a contractor. The three categories are: behavioral control, financial control and relationship of the parties.
When testing for behavioral control, the IRS and the courts look at facts to determine whether the company has the right to direct or control how the work is done by:
- The type and degree of instructions given to the worker by the company.
- The training provided to the worker by the company.
- Where the work takes place. (If at the company’s location, the greater likelihood that the worker is an employee).
When testing for financial control, the IRS and the courts review the facts to determine whether the business has a right to direct or control the financial and business aspects of the worker’s job, including:
- The extent to which the worker incurs significant unreimbursed business expenses (generally a contractor is not reimbursed for out of pocket expenses).
- Whether the company supplies the tools used in the work. (The less significant the worker’s skill or investment, the greater chance the worker is an employee).
- Whether the worker personally provides the services or whether the worker hires others to provide or assist with the services. (Workers who provide their own employees are more likely to be contractors).
- The method used in paying the worker. (Workers paid by the job indicate possible contractor status; being paid by the hour may indicate employee).
- The worker’s opportunity for profit or loss. (Workers who can realize a profit by completing a job quickly and efficiently or can incur a loss by taking longer than planned or incurring costs greater than anticipated seem to indicate contractor).
Relationship of the parties
When testing for relationship of the parties, the IRS and the courts review the facts to determine how the parties perceive their relationship including:
- Written contracts describing the relationship of the parties.
- To what extent the worker is available to perform services for other similar businesses.
- Whether the company provides the worker with employee-type benefits, like insurance, a pension, vacation or sick pay.
- The permanency of the relationship. (Does the contract have an end date?).
- The extent to which services performed by the worker are a key aspect of the regular business of the company.
Misclassifying workers can be costly
The issue comes down to one word control. The more control and supervision you exert over the workers’ schedule and production, the more likely the worker will be deemed an employee.
Possible costs to employer for misclassifying employee as a contractor
- Liability for back payroll taxes.
- Interest and penalties.
- Unpaid overtime, sick leave, or vacation pay.
- Other employee benefits.
- Subject to labor anti-discrimination laws.
- Workers’ comp insurance violations or fraud.
- Unemployment claims and premiums.
- Penalties for excess contributions to retirement plan due to reclassification.