Employee or Independent Contractor?

The proper classification of workers as employees or independent contractors is an important issue.  Companies may be tempted to treat their workers as independent contractors to save on payroll taxes and other costs.  However, if the circumstances surrounding the working relationship are indicative of an employer-employee relationship, the company could find itself in some trouble.  For example, effective January 1, 2012, the state of California can assess fines of up to $25,000 per instance of willful misclassification.

Generally, the classification is determined by the behavioral and financial control of the worker.  The IRS has identified the factors below that can be used to determine whether an individual is an independent contractor or an employee.  It is important to remember that all facts and circumstances surrounding the relationship be considered.  None of the identified factors is determinative and not all factors will be present in all cases.

  • Control of when, where, and how the worker performs services. Provision of instructions regarding when, where, and how the worker is to work is indicative of an employer-employee relationship. Independent contractors tend to have control of these matters.
  • Training. Training and a requirement to attend meetings are indicative of an employer-employee relationship.
  • Requirement that services be personally performed. Independent contractors are often not required to personally perform the services. However, there are exceptions.
  • Length of relationship. A long-term continuing relationship indicates an employer-employee relationship. However, this factor alone is not enough.
  • Work schedule and number of hours of service required. A set schedule indicates the control of an employer in an employer-employee relationship. Provision of services while performing services for others suggests an independent contractor relationship.
  • Control over technique or sequence. Control of the manner in which the worker performs required tasks suggests an employer-employee relationship.
  • Reports to firm. Submission of regular or periodic reports suggests a degree of control indicative of an employer-employee relationship. However, such a requirement may also exist for an independent contractor.
  • Payment method. Payments by the hour, week, or month suggest an employer-employee relationship. Payment by the job or based on invoices submitted by the worker are indicative of an independent contractor relationship.
  • Work-related expenses. Payment of the worker’s business and travel expenses suggests an employer-employee relationship. However, reimbursement of business and travel expenses might also be part of the arrangement between an independent contractor and the firm.
  • Location and work facilities. The requirement that services be provided on the firm’s premises suggests an employer-employee relationship.  Provision of work facilities, including tools, by the worker, especially if of a type not generally maintained by employees, indicates an independent contractor relationship.
  • Profit and loss potential. Workers likely to profit from the success of an enterprise and at risk of experiencing a loss on its failure are usually independent contractors. Workers paid a fixed rate based on time with no possibility of loss are more likely employees.
  • Restrictions on customers and clients. Workers who offer their services to the public on a regular, consistent basis are less likely to be employees.
  • Termination. The ability of the firm and worker to terminate the relationship for any reason without penalty indicates an employer-employee relationship.

Any federal tax advice contained in this article is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

Greg Tanner – is a Tax Principal at Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.