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Is the worker an employee or an independent contractor?
The determination of whether a worker is properly classified as an employee or an independent contractor is an important issue, as the Internal Revenue Service, Department of Labor, state agencies and the courts continue to step up enforcement.
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The IRS test often is termed the “right to control test” or “common law test,” as each factor is designed to evaluate who controls how work is performed. The more control a company exercises over how, when, where, and by whom work is performed, the more likely the workers are employees, not independent contractors. There is a 20-factor test the IRS uses in making its determination.
A worker does not have to meet all 20 criteria to qualify as an employee or independent contractor, and no single factor is decisive in determining a worker’s status. The individual circumstances of each case determine the weight the IRS assigns different factors.
The three most important factors IRS auditors are trained to consider are as follows.
- Instructions to worker: If you require him or her to follow instructions on when, where and how work is to be done, the worker probably should be classified as an employee.
- Job Training: If you provide or arrange for training of any kind, it is a sign you expect work to be performed in a certain way; therefore, the worker is an employee.
- Worker’s ability to make a profit or suffer a loss: An employee will always get paid; however, an independent contractor has a financial stake in his business.
To build a strong case, the company and worker should sign a written agreement and the pay should be by job or project versus time.
If the IRS considers a worker to be an employee because the employer has sufficient control over the worker to create an employment relationship, the IRS can hit you with a costly bill for the employment taxes you should have been withholding and paying.
There is also the reasonable basis test. This is considered a “safe harbor.” If you can show you had a reasonable basis for treating a worker as an independent contractor, the IRS is prohibited from reclassifying the worker as an employee either prospectively or retroactively. If one or more of the following conditions exists, the reasonable basis test is met:
- a court ruling in favor of treating workers in similar circumstances as non-employees;
- an IRS ruling (revenue ruling) stating that similar workers are not employees subject to employment taxes;
- an IRS Technical Advice Memorandum or Private Letter Ruling issued to your company, indicating a worker isn’t an employee;
- a past IRS payroll audit that didn’t find workers in similar positions at your company to be employees; or
- a longstanding, widely recognized practice in your industry of treating similar workers as independent contractors.
If you have any questions or concerns on whether you have classified your workers correctly, please contact a WK advisor for assistance at (573) 442-6171 or (573) 635-6196.
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