Tax Tip for Summer 2004
Common-Law
Factors Indicating Employee Status
Below we
have reproduced an excerpt from an article by the American Institute of
Certified Public Accountants (“AICPA”) regarding the common factors that the IRS
takes into account when determining employee vs. independent contractor status.
The factors are intended as guidelines, not as strict rules. The IRS itself
says, “the degree of importance of each factor varies depending on the
occupation and the factual context in which the services are performed.” The IRS
developed the factors based on relevant cases and rulings. They focus on the
substance of the arrangement—whether the person for whom the services are
performed exercises sufficient control to classify the worker as an employee.
1.
Instructions.
A worker who must comply with other persons’ instructions about when, where and
how he or she is to work is ordinarily an employee. This factor is present when
the person for whom the services are performed has the right to require
compliance.
2. Training. Requiring an experienced employee to work with the
worker, corresponding with the worker, requiring the worker to attend meetings
or using other training methods indicates the person for whom the services are
performed wants them done in a particular method or manner.
3.
Integration.
Integrating the worker’s services into the business operations generally shows
that he or she is subject to direction and control. When the success or
continuation of a business depends to an appreciable degree on the performance
of certain services, the workers who do them must necessarily be subject to a
certain amount of control by the business owner.
4. Services
rendered personally.
If the worker must render the services personally, presumably the person for
whom they are performed is interested in the methods used to accomplish the work
as well as in the results.
5. Hiring,
supervising and paying assistants.
If the person for whom the services are performed hires, supervises and pays
assistants, that generally shows control over the workers on the job. However,
if one worker hires, supervises and pays the other assistants under a contract
in which the worker agrees to provide materials and labor and is responsible
only for attaining a result, this indicates independent contractor status.
6.
Continuing relationship.
A continuing relationship between the worker and the person for whom the
services are performed indicates an employer-employee relationship exists. This
may occur when work is performed at frequently recurring although irregular
intervals.
7. Set
hours of work.
If the person for whom the services are performed establishes set work hours,
this indicates control.
8.
Full-time required.
If the worker must devote himself or herself substantially full-time to the
business of the person for whom the services are performed, the latter has
control over the amount of time the worker spends working and implicitly
restricts the worker from doing other gainful work. An independent contractor,
on the other hand, is free to work when and for whom he or she chooses.
9. Doing
work on employer’s premises.
If the individual performs the work on the premises of the person for whom the
services are performed, this suggests control over the worker, especially if the
work could be done elsewhere. Work done off the premises, such as at the
worker’s office, indicates some freedom from control. However, this fact by
itself does not mean 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
premises. Control over the place of work is indicated when the person for whom
the services are performed has the right to compel the worker to travel a
designated route, to canvass a territory within a certain time frame or work at
specific places.
10. Order
or sequence set.
If a worker must perform services in the order or sequence set by the person for
whom the services are performed, that factor shows the worker is not free to
follow his or her own pattern of work but must follow the established routines
and schedules of the employer. 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 it infrequently. Retaining the right to do so is
sufficient to show control.
11. Oral or
written reports.
A requirement that the worker submit regular or written reports to the person or
persons for whom the services are performed indicates a certain degree of
control.
12. Payment
by hour, week or month.
Payment by one of these three methods generally points to an employer-employee
relationship, provided this method 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 basis generally indicates the worker is an independent contractor.
13. Payment
of business or travel expenses.
If the person for whom the services are performed generally pays the worker’s
business and travel expenses, he or she is ordinarily an employee. To control
expenses, an employer usually retains the right to regulate and direct the
worker’s business activities.
14. Tools
and materials.
The fact the person for whom the services are performed furnishes significant
tools, materials and other equipment tends to show the existence of an
employer-employee relationship.
15.
Significant investment.
If the worker invests in facilities not typically maintained by employees (such
as an office rented at fair value from an unrelated party) and uses them to
perform services, that tends to indicate the worker is an independent
contractor. On the other hand, lack of investment in facilities indicates
dependence on the person for whom the services are performed for such
facilities. Accordingly, an employer-employee relationship exists.
16.
Realization of profit or loss.
A worker who can realize a profit or suffer a loss as a result of his or her
services (in addition to the profit or loss ordinarily realized by employees) is
generally an independent contractor. The worker who cannot is an employee. For
example, if a worker is subject to a real risk of economic loss due to a
significant investment or a bona fide liability for expenses, such as salary
payments to unrelated employees, that indicates the worker is an independent
contractor. The risk a worker will not receive payment for his or her services,
however, is common to both independent contractors and employees and thus is not
sufficient to support independent contractor treatment.
17. Working
for more than one entity.
If a worker performs more than de minimis services for multiple
unrelated persons or companies at the same time, that factor generally indicates
the worker is an independent contractor. However, a worker who performs services
for more than one person may be an employee of each, especially where the two
are connected.
18. Making
service available to the general public.
The fact a worker makes his or her services available to the general public on a
regular and consistent basis indicates an independent contractor relationship.
19. Right
to discharge.
The right to fire a worker is a factor indicating the worker is an employee and
the person with 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 he or she produces a result that meets the agreed contract
specifications.
20. Right
to terminate.
If the worker has the right to end his or her relationship with the person for
whom the services are performed at any time without incurring liability, this
indicates an employer-employee relationship.
When
considering the 20 common-law factors, the contracting party should resist the
temptation to focus on those in its favor and downplay or ignore factors that
are not. If a company designates someone as an independent contractor when a
majority, but not all, of the 20 common-law factors shows he or she is an
employee, it is only asking for trouble.
Exercising
excessive control over the activities of a service provider is one of the
factors that will put a contracting party at risk of reclassification. In almost
every case in which the IRS or the courts overturn an independent contractor
relationship, it is obvious there are a number of factors falling into the
employee status column. CPAs should encourage companies to proceed with caution
and keep a sharp eye on the courts. The judicial trend seems to be to bring the
service provider under the contracting party’s umbrella as an employee.
