Independent Contractor or Employee?
In contrast to employees, independent contractors are not protected by worker’s compensation and wage and hour laws (e.g., the right to overtime pay) and are not subject to payroll taxes and withholding for income taxes. Therefore, an employer whose workers are independent contractors can avoid the additional expense of taxes, insurance and overtime. As a result, many employers in Colorado and across the country misclassify their employees as contractors in order to lower their operating costs. In fact, taxing authorities and state/federal divisions of labor have made this area a primary target of their enforcement efforts and have recovered tens of millions of dollars in taxes, wages and penalties from employers illegally misclassifying employees as independent contractors.
The following summarizes the basic test and factors the United States Internal Revenue Service (IRS) uses to distinguish independent contractors from employees. Although reviewing these IRS factors can provide some guidance in analyzing your particular situation, the contractor vs. employee distinction is extremely fact intensive and based on the particular circumstances. Therefore, if you have any doubt about whether you are an independent contractor or an employee, please contact us for a free and confidential case evaluation. Misclassified independent contractors may be entitled to recover thousands of dollars in damages and unpaid overtime wages.
THE IRS CONTRACTOR/EMPLOYEE TEST
Fundamentally, whether a particular worker is an independent contractor or an employee is determined by the degree of control the employer has over the worker and his or her work. The IRS looks at three particular areas in making this determination: 1) Behavioral Control includes factors that show whether the employer has a right to direct or control how the work is done through instructions, training or other means; 2) Financial Control includes factors that show whether the employer has a right to direct or control the financial and business aspects of the worker’s job; and 3) Type of Relationship includes factors that show how the workers and the business owner perceive their relationship.
Within these broad categories, there are a number of specific factors that should be considered and that help determine whether an employee has been misclassified as an independent contractor:
- Instructions. Workers who must comply with instructions as to when, where, and how they work are more likely to be employees than independent contractors.
- Training. The more training workers receive, the more likely it is that they are employees. Independent contractors are supposed to know how to do their work and, thus, should not require training from the purchasers of their services.
- Integration. The more important that a type of worker’s services are to a business’s success or continuation, the more likely it is that they are employees, i.e., is the business in the same business as the purported contractor?
- Services rendered personally. Workers who must personally perform the services for which a business is paying are more likely employees. In contrast, independent contractors usually have the right to substitute other people’s services for their own in fulfilling their contracts.
- Hiring assistants. Workers who are not in charge of hiring, supervising, and paying their own assistants are more likely employees.
- Continuing relationship. Workers who perform work for a business for significant periods of time or at recurring intervals are more likely employees.
- Set hours of work. Workers for whom a business establishes set hours of work are more likely employees. In contrast, independent contractors generally can set their own work hours.
- Full time required. Workers required to work or be available full time are likely to be employees. In contrast, independent contractors generally can work whenever and for whomever they choose.
- Work done on premises. Workers who work at a business’ premises or at a place designated by the business are more likely employees. In contrast, independent contractors usually have their own place of business where they can do their work for you.
- Order or sequence set. Workers for whom the business sets the order or sequence in which they perform their services are more likely employees.
- Reports. Workers required to submit regular reports are more likely employees.
- Payment method. Workers paid by the hour, week, or month are more likely employees. In contrast, independent contractors are usually paid by the job.
- Expenses. Workers whose business and travel expenses are paid by the business are more likely employees. In contrast, independent contractors are usually expected to cover their own overhead expenses.
- Tools and materials. Workers who use tools, materials, and other equipment furnished by the business are more likely employees.
- Investment. The greater a workers’ investment in the facilities and equipment they use in performing their services, the more likely it is that they are independent contractors.
- Profit or loss. The greater the risk that a worker can either make a profit or suffer a loss in rendering their services, the more likely it is that they are independent contractors.
- Works for more than one person at a time. The more businesses for which a worker performs services at the same time, the more likely it is that they are independent contractors.
- Services available to general public. Workers who hold their services out to the general public (for example, through business cards, advertisements, and other promotional items) are more likely independent contractors.
- Right to fire. Workers whom a business can fire at any time are more likely employees. In contrast, a business’ right to terminate an independent contractor is generally limited by specific contractual terms.
- Right to quit. Workers who can quit at any time without incurring any liability to the business are more likely employees. In contrast, independent contractors generally cannot walk away in the middle of a project without running the risk of being held financially accountable for their failure to complete the project.