It is important to determine if someone is an employee or an independent contractor because independent contractors have to pay for their own health insurance and the full share of the Social Security (FICA) tax. However, an employee only pays half of the FICA tax and gets benefits such as health insurance, paid time off etc.
For federal tax purposes, The IRS used to apply 20 common law rules per Revenue Ruling 87-41 to determine whether a worker is an independent contractor or an employee. However, today the IRS examines the relationship between the worker and the business. All evidence of the degree of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories: Behavioral Control, Financial Control, and the Relationship of the Parties.
Behavioral Control covers facts that show whether the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
Instructions that the business gives to the worker. An employee is generally subject to the employer’s 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. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job. This includes:
- The extent to which the worker has unreimbursed business expenses;
- The extent of the worker’s investment in the facilities or tools used in performing services;
- The extent to which the worker makes his or her services available to the relevant market;
- How the business pays the worker; and
- The extent to which the worker can realize a profit or incur a loss.
- The extent to which the worker has unreimbursed business expenses.
Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreim-bursed expenses in connection with the services that they perform for their employer.
The extent of the worker’s investment. An independent contractor often has a significant investment in the facilities or tools 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 his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities and often advertise, maintains a visible business location, and is 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 often paid a flat fee or on a time and materials basis 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. An independent contractor can make a profit or loss but an employee cannot.
Relationship of the Parties covers facts that show the type of relationship the parties had. This includes:
- Written contracts describing the relationship the parties intended to create;
- The permanency of the relationship. If you engage 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 your intent was to create an employer-employee relationship; and
- 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 your regular business activity, it is more likely that you 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.
If you are an employee and think your employer incorrectly treated you as an independent contractor you can file form SS-8 and the IRS will determine your correct status. If you have any questions feel free to contact Gregory J. Spadea at Spadea & Associates, LLC in Ridley Park, Pennsylvania at 610-521-0604.