Employee vs. Independent Contractor: Worker Classification Rules

Many businesses try to hire “independent contractors” by issuing IRS Form 1099 and signing independent-contractor agreements. Unfortunately, these steps don’t guarantee that workers are legitimate subcontractors or independent contractors. Instead, federal and state guidelines generally focus on the worker’s job duties in order to determine the appropriate classification.

Each state can create additional rules and regulations pertaining to worker classification. Check with your state labor department for clarification on state-specific rules. However, the federal government’s guidelines, described below, generally provide enough clarity to determine proper worker classification.

Federal guidelines 1: IRS

The IRS looks at the degree of control a company exercises over a worker. The more control, the more likely the worker is an employee. Three factors are relevant:

• Behavioral control. Does the company control where, when, and how the worker performs work? If so, the worker looks more like an employee.
• Financial control. Is the worker paid hourly? Does she purchase her own tools and equipment? Can she realize a profit or loss regardless of the specific amount of time spent on a job? A worker who is paid hourly, and is provided with tools and materials to perform work, is more like an employee than an independent contractor.
• The overall relationship between the worker and the company. Are employee benefits provided in any form, such as insurance, vacation pay, retirement benefits, etc.? These items suggest an employer/employee relationship.

 

Federal guidelines 2: Department of Labor

The IRS is just one of the federal government agencies that looks at worker classification. The Department of Labor (DOL) also considers multiple factors when determining whether a worker is properly classified.  While the DOL takes more factors into account, many of them intersect and overlap with the IRS factors.

• The extent to which the work performed is an integral part of the employer’s business. If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer and less likely that the worker is in business for himself.
• Whether the worker’s managerial skills affect his opportunity for profit and loss. Does the worker supervise his own workers/employees? Does he purchase his own equipment? If the worker can control profit and loss by managing his affairs, he is more like an independent contractor.
• The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment (and bear some risk for a loss) in order for there to be an indication that he is an independent contractor.
• The worker’s skill and initiative. Both employees and independent contractors may be skilled workers. However, more unique worker’s skillset is, the more she resembles an independent contractor. Independent-contractor status is also indicated if she contracts with other businesses and companies.
• The permanence of the relationship between the worker and the company. Permanence or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee, as opposed to an independent contractor.
• The nature and degree of control by the employer. The analysis is similar to that of the IRS and focuses on the level of control exercised by the company over the worker.

 

On its own, no single factor conclusively determines classification. The overall situation must be reviewed to determine how a worker should be classified. Often a company’s underlying motive for a classification reveals the appropriate classification. If a worker is classified as an independent contractor for the purpose of reducing taxes, or reducing the amount of overtime paid out, she may properly be classified as an employee. But if a worker is used only occasionally, for convenience to the purposes, and for a unique service for which he provides his own tools and equipment, then perhaps he is a true independent contractor.

Find out more about worker classification at the Tree Care Industry Expo in Columbus, OH on November 2nd from 4:15-5:30pm. Hear more examples of the classification factors and types of control the DOL and IRS look for when conducting an audit.