How do you determine whether a worker is an employee or independent contractor? Establishing the employment status of workers is vitally important as the result dictates whether an employer will have employment tax and income tax withholding, deposit, and reporting obligations. Establishing such status also has important implications with regard to designing and administering employee retirement, health, and fringe benefit plans, as well as complying with federal, state, and local labor and employment laws and ordinances.
For federal tax purposes, a worker is classified either as an “employee” of the service recipient or as an “independent contractor.” A worker is considered to be an employee if he or she is one of the following: (1) a common law employee; (2) a corporate officer; (3) a statutory employee (e.g., agent-driver or commission-driver, full-time life insurance salesperson, home worker, traveling salesperson); or (4) an employee covered by an agreement under §218 of the Social Security Act.
The common law rules for determining whether a worker is an employee or independent contractor are described in IRS regulations. Generally, an employer-employee relationship exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. It is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so. In contrast, individuals such as physicians, lawyers, dentists, contractors, and subcontractors who follow an independent trade, business, or profession in which they offer their services to the public, generally are not employees.
Determining whether the common law control test is satisfied requires a review of all of the facts and circumstances. Historically, the IRS and the courts have employed a 20-factor test when examining the relationship between the worker and the employer, but other factors beyond the traditional factors may be relevant. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed. The factors are designed only as guides for determining whether an individual is an employee. Special scrutiny is required in applying the twenty factors to ensure that formalistic aspects of an arrangement designed to achieve a particular status do not obscure the substance of the arrangement - that is, whether the person or persons for whom the services are performed exercise sufficient control over the individual for the individual to be classified as an employee. If an employer-employee relationship exists, the designation or description of the relationship by the parties is irrelevant.
Misclassifying workers may result in significant adverse financial and legal consequences. Thus, it is extremely important that you understand these distinctions. Contact us if you have questions or concerns regarding the status of your workers.
Miller, Bahr & Wills, P.C.
