ARE YOUR INDEPENDENT CONTRACTORS REALLY INDEPENDENT CONTRACTORS?

 

Organizations utilize independent contractors (often referred to as "1099 workers") as opposed to employees for a variety of reasons; most often for economically motivated reasons.  By utilizing independent contractors, the employer reduces the organization's tax burden and avoids employee benefit costs.  This can, however, be a very slippery slope given the IRS' focus on cracking down on this practice with increased audit activity (a.k.a., revenue generation). 

 

In the event of an IRS or Department of Labor audit of your workforce, you may well find yourself in a costly predicament (fines and penalties, back payment of employment related taxes, back payment/liability for employee benefits to impacted workers).  Some insulation against liability exists if the contractor is "employed" by a temporary service firm or agency, or through a "temp to perm" arrangement, but that insulation is not absolute depending on the specifics of the working arrangement and/or contract.  

 

We are not advocating abandoning the practice of utilizing independent contractors; rather, we urge you to make a careful and conservative evaluation of workers being classified as independent contractors (conducted yourself or with the assistance of an independent third party) to ensure compliance and minimize risk to the organization.

 

IRS Independent Contractor Test

 

The IRS formerly used what has become known as the "Twenty Factor" test. Under pressure from Congress and from representatives of labor and business, it has attempted to simplify and refine the test, consolidating the twenty factors into eleven main tests, and organizing them into three main groups: behavioral control, financial control, and the type of relationship of the parties. Those factors appear below, additional comments regarding each one can be found on the IRS Publication 15-A, 2006 Edition, page 6 (PDF).

 

Behavioral Control
 
Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of :

 

A)  Instructions the business gives the worker. An employee is generally subject to the business' instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work:

 

• When and where to do the work
• What tools or equipment to use
• What workers to hire or to assist with the work
• Where to purchase supplies and services
• What work must be performed by a specified individual
• What order or sequence to follow

 

The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right.

 

B)  Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

 

Financial Control

 

Facts that show whether the business has a right to control the business aspects of the worker's job include: 

 

The extent of the worker's investment. An employee usually has no investment in the work other than his or her own time. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.

The extent to which the worker makes services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.

How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.

The extent to which the worker can realize a profit or loss. Since an employer usually provides employees a workplace, tools, materials, equipment, and supplies needed for the work, and generally pays the costs of doing business, employees do not have an opportunity to make a profit or loss. An independent contractor can make a profit or loss.

Type of relationship

Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. The power to grant benefits carries with it the power to take them away, which is a power generally exercised by employers over employees. A true independent contractor will finance his or her own benefits out of the overall profits of the enterprise.

The permanency of the relationship. If the company engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.

The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of the company's regular business activity, it is more likely that the company will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.