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Is your Worker an Independent Contractor or an Employee?

Rödl & Partner Tax Matters Vol 2013 – 5, republished in July 2024

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. It is intensely factual, and the stakes can be very high. If a worker is an employee, the company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages plus FUTA tax, and often provide the worker with fringe benefits it makes available to other employees. There may be state tax obligations as well. These obligations don’t apply for a worker who is an independent contractor. The business sends the independent contractor a Form 1099-NEC for the year showing what he or she was paid (if it amounts to $600 or more) and that’s it.

Under the “common law” rules developed by the courts, a worker generally is an employee for federal tax purposes if the employer has the right to control and direct the worker regarding the job he or she is to do and how he or she is to do it. Otherwise, the worker is an independent contractor. The employer doesn’t actually have to direct or control how the services are performed; it’s enough if the employer has the right to do so. The IRS usually applies the following factors to see if the employer has the right to direct and control the worker:

A worker who must comply with instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the business has the right to make the worker follow instructions. However, instructions regarding government standards are given little weight, as is the absence of instructions for professionals such as attorneys, who must follow the rules of their profession.
Training a worker by teaming an experienced employee with the worker, by corresponding with the worker, by requiring him or her to attend meetings, or by using other methods indicates the business wants the services performed in a particular method or manner. Ongoing training is a particularly strong sign of an employer-employee relationship, but orientation or information programs about company policies aren’t.
Integration of the worker’s services into the business operations generally shows the worker is subject to direction and control.
If the services must be rendered personally, the business probably is interested in the methods used to accomplish the work as well as in the results.
A business that hires, supervises, and pays assistants for a worker is exhibiting employer-like control over the worker on the job. Conversely, an independent contractor relationship is indicated if a worker is contractually obligated to hire, supervise, and pay assistants.
A continuing relationship between the worker and the business indicates an employer-employee relationship exists. A continuing relationship may exist where the worker is called in at frequently recurring, although irregular, intervals.
The fact that a business requires work to be performed on its premises suggests control over the worker (if the work could be done elsewhere). Work done off the premises, such as at the worker’s office, indicates some freedom from control. The importance of this factor depends on the type of services involved and whether an employer generally would require employees to do similar work on its premises.
A business exhibits control over a worker if it requires him or her to perform services in a specific order or sequence.
A business’s requirement that the worker submit regular or written reports indicates a degree of control over the worker.
Payment by the hour, week, or month generally points to an employer-employee relationship if this method of payment isn’t just a convenient way of paying a lump-sum agreed upon as the cost of a job. Payment by the job or on a straight commission basis generally indicates a worker is an independent contractor.
A business exhibits characteristics of an employer if it supplies a worker with significant tools, materials, and other equipment, or if the business ordinarily pays the worker’s business and/or traveling expenses.
A worker exhibits independent contractor status if he or she invests in facilities that aren’t typically maintained by employees (e.g., renting his or her own office). By contrast, an employee usually relies on the employer to provide the facilities needed to do the job.
A worker who can realize a profit or suffer a loss as a result of his or her services generally is an independent contractor, but a worker who can’t is an employee. The risk that a worker won’t be paid isn’t factored in.
A worker who performs more than minimal services for a number of unrelated businesses at the same time generally is an independent contractor. However, a person who works for more than one business may be an employee of each business, especially where the businesses are part of the same service arrangement.
The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
The right to fire a worker is a factor indicating that he or she is an employee. An independent contractor, on the other hand, can’t be fired as long as he or she produces the work that was contracted for.

There is no litmus test for exactly how many of these factors must be satisfied, nor are these factors uniformly applied.

Some employers that have misclassified workers as independent contractors are relieved from employment tax liabilities under Section 530 of the 1978 Revenue Act (not the Internal Revenue Code). In brief, Section 530 protection applies only if the employer: filed all federal returns consistent with its treatment of a worker as an independent contractor; treated all similarly situated workers as independent contractors; and had a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry has traditionally treated similar workers as independent contractors. Section 530 doesn’t apply to certain types of technical services workers.

Individuals who are “statutory employees,” (that is, specifically identified by the Internal Revenue Code as being employees) are treated as employees for social security tax purposes even if they aren’t subject to an employer’s direction and control (that is, even if the individuals wouldn’t be treated as employees under the common-law rules).

These individuals are agent drivers and commission drivers, life insurance salespeople, home workers, and full-time traveling or city salespeople who meet a number of tests. Statutory employees may or may not be employees for non-FICA purposes. Corporate officers are statutory employees for all purposes.

Individuals who are statutory independent contractors (that is, specifically identified by the Internal Revenue Code as being non-employees) aren’t employees for purposes of wage withholding, FICA, FUTA, or the income tax rules in general. These individuals are qualified real estate agents and certain direct sellers.

Some categories of individuals are subject to special rules because of their occupations or identities. For example, corporate directors aren’t employees of a corporation in their capacity as directors, and partners of an enterprise organized as a partnership are treated as self-employed persons.

Under certain circumstances, you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee.

Please let us know if you have any questions.

This publication contains general information and is not intended to be comprehensive or to provide legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Consult your advisor.

We have made reasonable efforts to ensure the accuracy of the information contained in this publication, however this cannot be guaranteed. Neither Rödl Langford de Kock LP nor any of its subsidiaries nor any affiliate thereof or other related entity shall have any liability to any person or entity which relies on the information contained in this publication, including incidental or consequential damages arising from errors or omissions. Any such reliance is solely at user's risk.

Any tax and/or accounting advice contained herein is based on our understanding of the facts, assumptions we have been asked to make, and on the tax laws and/or accounting principles in effect as of the date of this advice. No assurance is given that the conclusions would be the same if the facts or assumptions change, or are not as we understand them, or that the tax laws and/or accounting principles will not change subsequent to the issuance of these conclusions. In addition, we do not undertake any continuing obligation to advise on future changes in the tax laws and/or accounting principles, or of the impact on the conclusions herein.

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Elisa Fay

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Managing Partner Rödl National Tax

+1 404 525 2600

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