Worker classification is an important responsibility of any employer, with implications ranging from tax and withholdings liability to the employer’s liability for the worker’s conduct. For tax purposes, the IRS has previously laid out twenty non-exclusive factors that it considered when making the determination as to whether a worker is an independent contractor or employee. This Twenty Factors Test, as it came to be known, was actually an iteration of what had developed under the common law as a test used by judges for employee classification (known as the Right to Control Test). Although the IRS has formally moved to a “three factor” analysis that it considered to simplify the test, that analysis essentially re-focuses these same factors into three groups: (1) control over behavior of the worker, (2) financial control, and (3) the relationship between the employer and worker. As the IRS still relies on the extent the employer has the right to exercise control over the worker, the original and more detailed twenty factor analysis continues to provide guidance for employers.
The twenty factors laid out by the IRS, grouped under the revised three factor test’s categories, are:
To what extent does the company control or have the right to control what the worker does?
- Instructions. Employees are more often required to comply with employee instructions on specifics like when, where, and how they are to perform their duties.
- Training. Training shows control over the means, indicating an employee status.
- Services rendered personally. Indicates employer control over means and results and more likely to be an employee.
- Hiring, Supervising, and paying assistants. Employer hiring of workers staff indicates control and employee status.
- Set work hours. Employer setting indicates employee status.
- Doing work on employer’s premises. Employer controlling where work is performed indicates employee status.
- Set order to job duties. Employer controlling how job duties are to be performed indicates employee status.
- Reports. Requiring regular reports may indicate employer control and thus employee status.
- Payment. Independent contractors are usually paid by the job or on commission as opposed to hourly or weekly.
- Business and traveling expenses. Payment by employer is indicative that employee status exists.
- Tools and materials. Independent contractors generally provide their own tools, materials and equipment.
- Worker Investment. Significant worker investment in facilities not typical of employees (office space) is indicative of independent contractor status.
- Integration. If a worker’s duties are strongly tied to the success of a business, workers are more likely subject to more control and thus more likely an employee.
- Continuing relationships. When between worker and employer, may indicate employee status.
- Full time required. Worker required to work full time for single employer indicates employee status.
- Shared profits and losses. Ability to recognize profits and losses not generally realized by employees is indicative of independent contractor status.
- Multiple Employers. Workers performing services for more than one employer is indicative of independent contractor status.
- Services available to the public. Independent contractors generally make their services available to the public.
- Right to discharge. An employer possessing the right to discharge is indicative of employee status.
- Right to terminate. Workers are employees if they may terminate their status without incurring any liability to the employer.
The IRS will view the totality of the circumstances as it may exist in each situation and is not limited to those factors described above. The consistent theme to look for is whether the employers exercise control over the means, manners, and methods of the worker’s performance. Courts often use different variations of this type of factor test revolving around employer control for the determination of employee status when relevant for other legal purposes.
In addition to the above factor analysis to delineate between an employee and an independent contractor, the IRS has specifically described certain job duties and situations to constitute an in-between status of “statutory employee” for federal tax purposes. Some examples of workers classified as statutory employees include a delivery driver of certain products paid on commission, a life insurance sales agent selling primarily for a single company, or a full time traveling sales person of goods sold for resale or used in the buyer’s operation. In addition to meeting a criterion described above, all of the following must also be true for a worker to be a statutory employee: (a) all the services are to be performed personally by the worker, (b) the worker does not have a substantial investment in the equipment used, and (c) the services are performed on a continuing basis for the same employer. There are also “statutory non-employees” for IRS purposes, which includes direct sellers, companion sitters and licensed real estate agents who meet certain additional requirements.
General tax differences of these four classifications are as follows:
- Employee (w2): employer responsible for certain payroll tax withholdings from wages. Employees may not claim general business deductions related to the work on their tax filings.
- Independent Contractor (1099): Employer not liable for tax withholdings. Worker liable for self-employment taxes. Worker may claim business expense deductions on their taxes.
- Statutory Employee (w2): Employer responsible for certain payroll tax withholdings from wages such as FICA, but does not withhold federal income tax. Statutory employees are not liable for self-employment taxes but are allowed to deduct business expenses as an independent contractor would.
- Statutory Non-Employee (1099): Treated as self-employed for all federal tax purposes.
The consequences for misclassification could be liability for back employment taxes owed, if there was no reasonable basis for the misclassification. Where a reasonable basis for the misclassification existed and the employer treated the worker consistent with the misclassification for all purposes, relief from liability may be available. Employers and workers can also file an SS-8 form with the IRS to request that the IRS make the determination of employment status.
Classification may also be important in the application of other employment-related laws such as the federal Age Discrimination in Employment Act, Family Medical Leave Act, Americans with Disabilities Act, Title VII, the Fair Labor Standards Act (FLSA), and their state counterparts as such may exist (which may have different thresholds) as well as worker’s compensation laws. Although each law may define “employee” for its own purpose, the acts (and the courts interpreting the laws) often look to the same or similar factors as described above and used by the IRS.
An employer or worker with specific questions as to worker classification should contact a qualified attorney or accountant to have specific concerns addressed by advice tailored to the circumstances. Nothing in this article constitutes legal or tax advice nor may any such information be used for the purpose of federal or state tax protection. Laws and regulations change frequently and vary greatly between jurisdictions. As such, the accuracy or correctness of any information provided cannot be guaranteed.
ABOUT THE AUTHOR - BRIAN CASSERLY
Brian Casserly is an attorney at Gutwein Law. He received his MBA from Ball State University and graduated from IU McKinney School of Law in 2013. He focuses primarily on business law, non-profit organizations and real estate transactions.