Independent Contractor vs Employee

You may be wondering whether your worker should be classified as an independent contractor or employee. This is a question we often address with our clients as it could have far reaching consequences should an employer misclassify some, or all, of its workforce. If your worker is an employee, you must withhold federal and state income taxes, pay the employer’s share of Social Security and Medicare taxes, plus you may be liable for Federal and State unemployment insurance. In addition, you may be required to offer your worker fringe benefits on par with your other employees.

Definition of an Employee
According to Revenue Ruling 75-343, a worker is an “employee” if the worker meets the common law (i.e. case law) rules to determine an employer-employee relationship. Numerous test to determine worker relationship have been cited within case law over the years, but the most important test is the “control test.” Under the control test, and employer-employee relationship exists when the employer has the right to control and direct the worker in relation to both (1) the result to be accomplished and (2) the means by which the worker is to accomplish the intended result. In other words, the employer controls both what work is to be done and how the work is to be done. Note, that the employer does not necessarily need to (in fact) exhibit control for the employer-employee relationship to be established. Rather, merely having the right to control the employee will establish the employer-employee relationship under the common law test.

It is possible for a worker to serve a dual capacity for a single business. That is, for some work assignments the worker may be considered an employee and for others the worker is an independent contractor. A separate worker relationship is determined for each role the worker plays within the company.

Additional Factors to Consider
Although the control test is the principal factor when determining the worker relationship, it is not the only factor. There are numerous other factors which have evolved under common law. Listed below are several other factors to consider (this is not an exhaustive list):

• Does the employer provide ongoing training to its worker? Ongoing training is a strong sign indicating an employee relationship.

• How are the payments structured? Payment by the hour, day, etc. indicate and employee relationship, and payment by the job indicates an independent contractor relationship.

• Does the worker perform similar services to several unrelated businesses? If so, this indicates the worker is an independent contractor.

• How integrated is the worker within the employer’s operations? The more integrated the worker is, the more likely an employee relationship exists.

• Does the employer require the worker to work on premises? If so, this indicates an employment relationship compared to allowing the worker to work from home or elsewhere.

Misclassifying Workers
As you can see, determining a worker’s relationship depends on the exact facts and circumstances. There is no bright line test under the common law rules. Because of this, employers can easily misclassify workers – potentially exposing themselves to significant financial consequences.

Section 530 of the 1978 Revenue Act provides relief from employment tax liabilities for potentially misclassified workers. Specifically, it provides relief to companies who misclassify a worker as an independent contractor when in fact the worker should have been classified as an employee. The relief applies provided the employer (1) filed all federal tax returns consistent with its treatment of the worker as an independent contractor; (2) treated all similar workers as independent contractors; and (3) had a “reasonable basis” to treat the worker as an independent contractor. An example of “reasonable basis” is when it is common for other companies in the same industry to treat similar workers as independent contractors.
When in doubt, contact your accounting or legal professional to help determine the correct worker classification. Classifying your worker correctly from the start could save you significant hardships down the road.