Independent Contractor vs. Employee
“A little bit independent in your walk
A little bit independent in your talk
A little bit independent with your smile
A little bit independent in your style”
– Fats Waller “A Little Bit Independent”
With the start of a new year, many people are thinking about changes they want to make. Losing weight, home projects, and for business owners – the direction of their businesses. If business has been growing, you may need to hire additional help. This is exciting and daunting all at the same time. Beyond wages, there are other costs to consider: employee benefits, workers compensation, unemployment and FICA taxes, payroll processing costs – all of these are additional costs that the employer may or will have to face.
Because of this, the temptation for some smaller businesses is to instead classify hired persons as “independent contractors”. This can be much easier and eliminates the costs mentioned above. The problem? In many cases, the person is not truly an independent contractor but rather a bona fide employee.
With all due apologies to Fats (see the song above) your new worker is not “a little bit independent” in terms of whether he or she is an independent contractor. Properly assessed, the worker is either a contractor or an employee – not a “little bit” of anything – any more than someone is a “little bit pregnant.”
Why does it matter? Well, there are a couple of entities to which this is very important. And they are getting more and more touchy about it and are increasingly focused on making sure that employers handle this matter correctly. Who are these folks? Oh, just a couple of small organizations known as the Internal Revenue Service and the Department of Labor. So yeah, it’s a good idea to make sure we’re approaching this the right way.
BUT…they haven’t made it is easy to figure it out and reach the right conclusion. (It’s the government – are you surprised?)
The Difficulty in Finding a Definition
Beyond the temptation to classify all workers as independent contractors, it can get pretty confusing once you actually start digging through the laws. A well intentioned employer can get very different answers from different sources. Here are some quotes from governmental agencies to illustrate (feel free to skim to just the bolded sections):
- “Whether or not a worker is covered by a particular employment, labor, or tax law hinges on the definition of an employee. Yet, statutes usually fail to clearly define the term “employee”, and no single standard to distinguish between employee and independent contractor has emerged.” – Department of Labor
- “The Supreme Court has said that there is no definition that solves all problems relating to the employer-employee relationship under the Fair Labor Standards Act (FLSA). The Court has also said that determination of the relation cannot be based on isolated factors or upon a single characteristic, but depends upon the circumstances of the whole activity.” – Department of Labor
- “The Internal Revenue Service developed a list of 20 factors that may be examined in determining whether an employer-employee relationship exists. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed; factors other than the listed 20 factors may also be relevant.” – Internal Revenue Service
- “A test is used in most states to determine status under workers’ compensation laws. The so- called “economic realities test” or a hybrid of the right-to-control and economic realities test often is used by courts to determine independent contractor status in other circumstances.” – Department of Labor
Confused yet? “No definition, “20 factors” and then some more, “importance varies”, “hybrid” – no wonder business owners do not know what to do!
Most Important Factors
Given the complexity of the issue, I would be remiss if I tried to comprehensively cover the subject in one article. First, as outlined above, no one article could ever fully capture all of the factors involved. Second, even if I tried, the article would be so long that it would put you to sleep. But here are quick descriptions of a few of the most key factors that the courts have taken into consideration:
- Degree of control the employer has/degree of independence the worker has
- Skill level required for the job
- Permanency of relationship
- Worker’s opportunities for profit/loss
- Amount of worker’s investment in facilities/equipment
- How integral the worker’s efforts are to the company
Again, those are just short blurbs on a very few of the many, sometimes conflicting parameters that are set out. What if a worker has little independence but a lot of investment in their own facilities and equipment? A long relationship but not integral to the company? Mix in those factors along with the 20+ from the IRS and it can become overwhelming.
Taxpayer Relief and Assistance
I have researched these laws extensively and know which factors are the most important in each situation and how they all intertwine. Contact me and we can discuss your specific situation and see how you need to treat new employees and if you need to reclassify existing employees.
Be on the lookout in a few weeks for an email outlining a voluntary IRS program to abate some of the penalties that could be assessed for incorrect worker classification or call me and we can discuss it. But don’t try to make the decision on your own. The new temptation might be to retreat in fear and automatically call everyone an employee – just the be safe. But if it’s not necessary to do so, you might be costing your business unnecessarily. Incorrect worker classification in either direction can be a very costly mistake. I can help.
IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.