Posted by Carmen Garcia

How the IRS Determines Independent Contractor Status

How the IRS Determines Independent Contractor Status

One of the most common mistakes businesses make is not having the right status for a worker. The options are employees or self-employed.

An independent contractor (IC) carries out an independent commercial or professional activity and provides services to the general public. An independent contractor is considered capable of controlling their work, not the employer. Instead, the employer controls and directs the employee's work.

Many businesses classify workers as independent contractors because it is cheaper than hiring employees. These companies avoid:

  • Adhering to laws on minimum wages, overtime, and other wages.

  • Being subject to labor laws such as ADA, OSHA, and equal pay 

  • Payment of unemployment insurance premiums and workers' compensation benefits

  • Withholding social security and health insurance taxes and paying some of these taxes

But misclassifying workers as independent contractors rather than employees can have huge costs, including paying FICA (Social Security and Medicare) taxes on workers and heavy fines and penalties. 


How Does the IRS Determine Employee Status?

The I.R.S uses common law principles to determine whether an employee is an independent contractor or an employee. This IRS exam relates to federal payroll taxes: federal income tax, FICA taxes on Social Security and Medicare, and federal taxes on unemployment.

In the past, a "20-factor test" has been used to assess workers and determine whether they are employees or independent contractors. These factors have been grouped into three general categories for the IRS to analyze the specific situation:

  • Behavior control,

  • Financial control 

  • The relationship between the parties.

When considering the factors below, you should keep in mind that the IRS is not looking specifically at a factor, but one factor may be enough for the IRS to determine that a worker is an employee. There is no "specific number" of factors that determine the condition.

The IRS considers a worker an employee unless proven otherwise. Therefore, the onus is on the employer to prove that they have correctly classified a worker.


Factors in determining the status of the worker

The I.R.S no longer uses this specific 20-question test to determine employee status, but it can help you understand the depth of what is being assessed.

  • Available to the general public: The availability of services for workers to the general public indicates an independent contractor's status.

  • The worker's direction or actual instruction: A worker who must follow instructions on when, where, and how to work is usually an employee. Instructions can take the form of manuals or written procedures that show how to achieve the desired result.

  • The exclusivity of work: Working for more than one person at the same time usually indicates the status of an independent contractor, as the worker is generally free in these cases from the control of any of the companies.

  • Full-time work: Full-time work needed for the business indicates employer control, preventing the worker from performing other paid jobs.

  • Hours of work: The fixing of working hours fixed by the employer prevents the worker from the master of his own time, which is one of the key things independent contractors are known for.

  • Integration of services: The integration of personal services into business operations usually shows that they are subject to direction and control.

  • Investments: A large investment by the worker in the facilities used to provide services to others tends to have independent status.

  • Method of payment: Suppose the payment method is hourly, weekly, or monthly. In that case, there is likely an employer-employee relationship, while payment of commission or labor is usual when the worker is an independent contractor.

  • Ongoing relationship: The existence of a permanent relationship between a person and the person it serves indicates an employer-employee relationship.

  • Order of execution: If the order in which the services are provided is or can be determined by the employer, control by the employer may be indicated.

  • Payment of expenses: The payment of the worker's labor costs by the employer expenses control of the worker.

  • Profit or loss: The possibility of gain or loss for the worker due to the services provided usually shows an independent contractor's status.

  • Right of discharge: The employer has the right to discharge. On the other hand, an independent contractor cannot be "dismissed" without incurring liability if he produces a result specified in his contract.

  • Similar workers: Hiring, supervising, and paying assistants in the same job usually shows the employer's control over the job.

  • Submitting of reports: The submission of periodic oral or written reports indicates control, as the worker must be held accountable for his actions.

  • The personal nature of the services: If the services are provided in person, it indicates an interest in the methods and the results. Lack of control may indicate when the person has the right to hire a replacement with the employer's permission or knowledge.

  • The right to quit: The right to resign at any time, without incurring liability, indicates an employer-employee relationship.

  • Tools and materials: The provision of tools, materials, etc., by the employer, indicates control over the worker.

  • Training: The training of a worker by an experienced employee who works, by correspondence, through compulsory participation in meetings and other methods is a factor that indicates the employer's mastery over the specific performance method.

  • Working indoors: If the employee is obliged to carry out the work on the employer's premises, the employer's control is implicit, especially when the work is likely to be performed elsewhere.


Status test for independent contractor status

Each state has its way of assessing a worker's status for state wages, hours, and working conditions. Many states most often use what is called the three-factor ABC test. This test, in summary, requires compliance with these three factors for the worker to be considered an independent contractor:

  • The employee is not under the employer's control to perform the work.

  • The worker must be "naturally engaged" in an independent trade or commercial activity equal to the work performed for his employer.

  • Work should NOT be part of the employer's usual course of activities.


Getting a review by the IRS 

Want to know if your workers are classified correctly? You will have to apply to the IRS using Form SS-8 to get a determination letter telling you how you view your workers, either as employees or independent contractors.

You can also register with the IRS if you have classified workers as independent contractors. This "530 relief" application allows you to obtain an exemption from liability or payment if you have incorrectly classified workers as independent contractors. Consider the factors that may work in your favor, such as good faith efforts to comply with the law.


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Carmen Garcia
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