Making the Distinction: Independent Contractor or Employee?

HR & Employment Law for Entrepreneurs Series

By Adrienne B. Haynes, Esq.

Managing Partner, SEED Law

One of the most frequent early questions we get asked at SEED Law from growing companies is how to understand and distinguish between the independent contractor and employee relationship.

This distinctions between the employee and independent contractor relationship are drawn from common law tests developed over the years from case law. In 1987, the IRS reviewed the rulings and established the “20 Factors Test,” intended for use as a sliding scale consideration tool. In combination with the industry, facts, and other considerations, the listed factors made it easier to determine if the appropriate relationship was more of an employee or independent contractor. If you worked through the list and had more of one type of characteristics than the other, you would have to research further to find out which forms or associated taxes were applicable for an independent contractor or employee.

1. Instructions

2. Training

3. Integration

4. Services rendered personally

5. Hiring, supervising, and paying assistants

6. Continuing relationship

7. Set of work hours

8. Full time required

9. Services available to the general public

10. Right to discharge

11. Right to terminate

12. Doing work on the employer’s premises

13. Order or sequence test

14. Oral or written reports

15. Payment by the hour, week, or month

16. Payment of expenses

17. Furnishing tools and materials

18. Significant investment

19. Realization or profit or loss

20. Working for more than one firm at a time

Of course, the IRS can and does consider factors beyond the twenty listed, and how they are considered and weighed really is determined on a case by case basis.

Today, the IRS has streamlined the determination with a three-factor control test. This takes into account behavioral control, financial control, and the type of relationship of the parties.

Behavioral control: The behavioral control factor looks at the right to direct or control how the worker carries out the assigned work. In making this determination, the IRS takes into account the following factors:

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

Financial control: The financial control factor takes into account the involvement of a company on the economic aspects of the assigned work. In making this determination, the IRS takes into account the following factors:

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

Type of relationship: This final factor looks at how the parties in question perceive their relationship, including how they’ve documented their agreement and additional benefits conferred. To make this determination, the following factors are weighed:

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

After you determine the most appropriate way to categorize the position or team member, be sure to document the relationship well to keep your HR department in compliance.

If the relationship is ever in question, the IRS will ask you to complete an SS-8 within a designated time frame and include any accompanying documentation. You’ll want to have a complete record in order to prepare a complete and accurate response. If it is found that an employee is misclassified as an independent contractor, the employer may be able to change the classification in advance if certain conditions are met. Otherwise, the liabilities can include back pay, social security payments, Medicare payments, worker’s compensation contributions, unemployment premiums, interest and penalties, and any associated attorney’s fees.

Making this determination may seem simple, but it should be weighed in the hiring considerations of each position and monitored over the course of the relationship.

This article is an overview of a small portion of employment law considerations and does not cover every legal right or obligation, consideration, exception, or restriction. Every business decision should be well researched and discussed with a professional before being made.

To schedule a consultation with a SEED Law attorney, you can give us a call at (816)945–4249 or schedule your consultation today here.

Additional Resources:

About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, https://www.irs.gov/forms-pubs/about-form-ss-8 (last visited Apr 12, 2020).

Behavioral Control, https://www.irs.gov/businesses/small-businesses-self-employed/behavioral-control (last visited Apr 12, 2020).

Financial Control, https://www.irs.gov/businesses/small-businesses-self-employed/financial-control (last visited Apr 12, 2020).

Independent Contractor (Self-Employed) or Employee?, https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee (last visited Apr 12, 2020).

Present Law and Background Relating to Worker Classification for Federal Tax Purposes, https://www.irs.gov/pub/irs-utl/x-26-07.pdf (last visited Apr 12, 2020).

Type of Relationship, https://www.irs.gov/businesses/small-businesses-self-employed/type-of-relationship (last visited Apr 12, 2020).