DETERMINING WHETHER JOE IS EMPLOYEE OR INDEPENDENT
CONTRACTOR
Unfortunately, as far as the various government agencies are concerned,
there is not one single test that determines whether Joe is your
employee or an independent contractor. Even more difficult, it is
quite possible that for the purposes of one government agency Joe is
considered to be an independent contractor while for another he is
treated as an employee.
> The IRS/Common Law "Control" Test
The IRS follows the common law "control" test for determining whether
someone is an employee or independent contractor. This test looks
at 20 factors as being indicative (and only indicative) of whether
the person is an employee or independent contractor. The test
basically involves a balancing of these factors which way does the
scale tip?
Here are the IRS factors:
1. Whether the worker can earn a profit or suffer a loss from the
activity (if so, the more likely it is that the worker is an independent
contractor).
2. Whether the worker is told where to work (indicative of employee
status).
3. Whether the worker offers his or her services to the general
public (indicative of independent contractor status).
4. Whether the worker can be fired by the hiring firm.
5. Whether the worker furnishes the tools and materials needed to
do the work (indicative of independent contractor status).
6. Whether the worker is paid by the job or by the hour (independent
contractors are more likely to be paid by the job; employees by the
hour).
7. Whether the worker works for more than one firm at a time
(indicative of independent contractor status).
8. Whether the worker has a continuing relationship with the hiring
firm (indicative of employee status).
9. Whether the worker invests in equipment and facilities (indicative
of independent contractor status).
10. Whether the worker pays his or her own business and traveling
expenses (indicative of independent contractor status).
11. Whether the worker has the right to quit without incurring
liability (indicative of employee status).
12. Whether the worker receives instructions from the hiring firm
(indicative of employee status).
13. Whether the worker is told how to perform the work (indicative of
employee status).
14. Whether the worker receives training from the hiring firm (indicative
of employee status).
15. Whether the worker performs the services personally.
16. Whether the worker hires and pays assistants (indicative of
independent contractor status).
17. Whether the worker sets his or her own working hours (indicative
of independent contractor status).
18. Whether the worker provides regular progress reports to the
hiring firm.
19. Whether the worker works full-time for the hiring firm (indicative
of employee status).
20. Whether the worker provides services that are an integral part
of the hiring firm's day-to-day operations (indicative of employee
status).
It is important to note that none of the above factors are, of themselves,
determinative. The IRS will balance all of the factors to determine
which side of the equation is favored.
> Other Agencies
The other government agencies with which you need to be concerned
are:
1. Your state Unemployment Compensation Board.
2. Your state Workers' Compensation Insurance Agency.
3. Your state Tax Department.
4. Your state/federal Department of Labor.
Unfortunately each state agency varies in its approach to determining
whether a worker is an employee or independent contractor. Many
states' agencies use a statutory test focusing on just a few of the "control"
test factors. You should therefore find out the factors that your state's
agencies take into account before hiring any independent contractors.
Most of this information will be available on the agency's website. If not,
call them and get them to send you information about their policies.
PROTECTING YOURSELF
OK, so you know the difference between an independent contractor
and an employee, you know the advantages and disadvantages of
hiring independent contractors and you know the dangers of
misclassification. How do you protect yourself?
> Independent Contractor Agreement
First and foremost, arm yourself with the IRS' control test factors and
the tests used by the various government agencies in your state.
Once you have that information, you can structure your arrangements
with your independent contractors accordingly. These arrangements
should be reduced to writing, in the form of an independent contractor
agreement.
An independent contractor agreement should contain a description of
the services the independent contractor is to perform, by when they
are to be performed and the amount the independent contractor is
to receive in return for satisfactory service.
This agreement can be very helpful evidence in proving that the
worker's status was independent contractor rather than employee.
Although such an agreement is insufficient by itself (if you nonetheless
treat the independent contractor as an employee the agreement
will be worthless for this purpose), if the factors weighed by the IRS
under the control test are evenly balanced, an independent contractor
agreement may well tip the scales in your favor.
> Screening
Before hiring an independent contractor, put him or her through a
few hoops first. It's a good idea to prepare some form of questionnaire
to extract the sort of information you would need to be able to prove
in support of your argument that the worker is, in fact, an independent
contractor and not an employee. Examples of such information
(courtesy of the NOLO website - http://www.nolo.com) include:
1. Whether the worker has formed a legal entity for his or her business.
2. Whether the worker has filed a fictitious business name (also known
as a "DBA" or "doing business as").
3. The worker's business address and telephone numbers.
4. The number of employees employed by the business.
5. Whether the worker has any professional or business licenses.
6. References from other business for whom the worker has performed
services as an independent contractor.
7. How the worker markets his or her business.
8. Whether the worker maintains an office separate from his or her
home.
9. A description of the equipment and facilities the worker owns and
will use in the project.
10. Whether the worker has business cards and stationery etc..
11. A listing of the types of insurance coverage the worker has
for his or her business.
Request documents that evidence the responses to the above questions.
For example, get copies of fictitious business name statements,
professional and business licenses; references; business cards and
stationery and insurance policies.
At the end of the day, whether you hire an employee or an independent
contractor is a decision for you and your business. If you feel you can
adequately protect yourself against an allegation of misclassification
then, by all means, follow the independent contractor route if that makes
most sense to you. But if you don't feel confident in managing the
relationship to protect yourself from such a charge, for your own
peace of mind, you may be well advised to hire an employee even if
that is more expensive up-front. After all, if you get it wrong, you'll be
paying those additional costs anyway in the form of back-taxes (and
interest and penalties to boot).
About the Author
Elena Fawkner is editor of A Home-Based Business Online...
practical home business ideas for the work-from-home
entrepreneur.
http://www.ahbbo.com