Accountants CPA Hartford
William Brighenti, Certified Public Accountant
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Office Address:  46 Mildrum Road, Berlin, Connecticut 06037-2423      Phone:  (860) 828-3269      Email:  info@cpa-connecticut.com
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Employee or Independent Contractor?
Not knowing the difference can prove costly to you!

Many employers erroneously think that they can "hire" individuals as independent contractors simply by having them agree to work under that designation, orally or in writing in the form of a contract.  Nothing could be further from the truth.  There are specific criteria established in Revenue Ruling 87-41 for determining whether one employed is an employee or an independent contractor, leaving the burden of proof encumbent upon the employer to substantiate the worker's status as an independent contractor.  Commonly known as the "Twenty Factor Test", these criteria should be reviewed by every employer whenever there is a question regarding a worker's status as an independent contractor or as an employee:  the penalties for failing to do so can be severe, including back federal and state employment and income taxes, interest, and thousands of dollars in penalties.  Some employers mistakenly think that the Internal Revenue Service or Social Security Administration will never discover any misclassificaton of a worker's status; however, because disgruntled workers—especially those recently severed from employment and desiring unemployment compensation—often are the whistle blowers to the federal and state governments, employers need to adopt a much more prudent posture in classifying a worker's status.

According to the IRS, the main issue in determining a worker's status is the degree of control an employer has or can have over the worker.  Under the common law, the treatment of a worker as an independent contractor or an employee originates from the legal definitions developed in the law of agency --whether one party, the principal, is legally responsible for the acts or omissions of another party, the agent --and depends on the principal’s right to direct and control the agent.  Following the common law standard, the employment tax regulations provide that an employer-employee relationship exists when the business for which the services are performed has the right to direct and control the worker who performs the services. This control refers not only to the result to be accomplished by the work, but also the means and details by which that result is accomplished. In other words, a worker is subject to the will and control of the business not only as to what work shall be done but also how it shall be done. It is not necessary that the business actually direct or control the manner in which the services are performed; it is sufficient if the business has the right to do so.

As an aid to determining whether an individual is an employee under the com­mon law rules, twenty factors or elements have been identified as indicating whether sufficient control is present to establish an employer-employee relationship.  The twenty factors are enumerated below.
  1. Instructions:  A worker who is re­quired to comply with other persons' in­structions about when, where, and how he or she is to work is ordinarily an em­ployee.  In other words, the principal has the right to control how the job gets done and not merely the right to require an end result.  The more detailed the instructions are that the worker is required to follow, the more control the business exercises over the worker, and the more likely the business retains the right to control the methods by which the worker performs the work. Absence of detail in instructions reflects less control.
  2. Training:  Detailed methods and procedures to be used in performing a task—as well as periodic or on-going training provided by a business about procedures to be followed and methods to be used—indicates that the business wants the services performed in a particular manner, and is strong evidence of an employer-employee relationship.
  3. Integration:   If the employee’s services are an integral and important part of the operations of the business, it suggests that the worker must be subject to the direction and control of management, and, consequently, is an employee of the company.
  4. Services Rendered Personally:  If the services must be rendered personally, presumably the principal for whom the services are performed is in­terested in the methods used to accom­plish the work as well as in the results. An employee often does not have the ability to assign his work to other employees; an independent contractor may delegate the work to others.
  5. Hiring, Supervising, and Paying As­sistants:  If the principal for whom the services are performed hires, super­vises, and pays assistants, that factor gen­erally shows control over the workers on the job and is indicative of an employer-employee relationship.  An independent contractor ordinarily hires, supervises, and pays assistants under a contract that requires him to provide materials and labor and to be responsible only for the result.
  6. Continuing Relationship:  If a business engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence of its intent to create an employment relationship.  A "continuing relationship" between employer and employee may exist even where work is performed at frequently recurring although irregular intervals.
  7. Set Hours of WorkThe establish­ment of set hours of work by the principal for whom the services are per­formed is a factor indicating control and an employment arrangement.  An independent contractor ordinarily establishes his own hours and schedule.
  8. Full Time RequiredIf the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work.  An employee normally works full time for an employer.  An independent con­tractor, on the other hand, is free to work when and for whom he or she chooses.
  9. Doing Work on Employer's Prem­ises:  If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker and an employer-employee relationship, espe­cially if the work could be done else­where.  An independent contractor may perform the work wherever he or she desires as long as the contract requirements are met.
  10. Order or Sequence Set:  If a worker must perform services in the order or se­quence set by the employer, that requirement suggests control over the worker and an employer-employee relationship.  An independent contractor may perform the work in whatever order or sequence he deems appropriate or convenient as long as the end results are achieved and all contract requirements are met.
  11. Oral or Written Reports:  A require­ment that the worker submit regular or written reportsto the person or persons for whom the services are performed in­dicates a degree of control over the process rather than the end result of a contractual performance.   Similarly, an evaluation system measuring compliance with performance standards concerning the details of how the work is to be performed, the system and its enforcement are evidence of control over the worker’s behavior and indicative of an employer-employee relationship.
  12. Payment by Hour, Week, MonthA worker who is compensated on an hourly, daily, weekly, or similar basis is guaranteed a return for labor. This is generally evidence of an employer-employee relationship, even when the wage or salary is accompanied by a commission.  Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
  13. Payment of Business and/or Trav­eling ExpensesIf the person or persons for whom the services are performed or­dinarily pay the worker's business and/or traveling expenses, the worker is ordi­narily an employee.  If expenses are unreimbursed, then the opportunity for profit or loss exists, and suggests an independent contractor relationship.
  14. Furnishing of Tools and MaterialsThe fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.  
  15. Significant InvestmentIf the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees, that factor tends to indicate that the worker is an independent contractor. Although not every independent contractor need make a significant investment, almost every independent contractor will incur an array of business expenses, including rent, utilities, equipment, advertising, insurance, supplies, materials, repairs and maintenance, etc.  On the other hand, lack of investment in facilities in­dicates dependence on the person or per­sons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee rela­tionship.
  16. Realization of Profit or LossIf the worker can make a profit or suffer a loss, the worker may be an independent contractor. Employees are typically paid for their time and labor
    and have no liability for business expensesee.  The ability to realize a profit or incur a loss is probably the strongest evidence that a worker controls the business aspects of services rendered and is therefore an independent contractor rather than an employee.
  17. Working for More Than One Firm at a Time:  If a worker performs services for a
    multiple of unrelated firms at the same time,
    that factor generally indicates that the worker is an independent contractor.
  18. Making Service Available to Gen­eral PublicThe fact that a worker makes his services available to the general public on a regular and consistent basis indicates an independent contractor re­lationship.  An independent contractor is generally free to seek out business opportunities.  Indeed, the independent contractor’s economic prosperity depends on doing so successfully.  As a result, independent contractors often advertise, maintain a visible business location, and are available to work for the relevant market.
  19. Right to DischargeThe right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an em­ployer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifica­tions.
  20. Right to TerminateIf the worker has the right to quit a job at will without incurring liability, that worker is generally an employee.
Companies that hire unincorporated individuals or entities as independent contractors in particular are targets for IRS and Social Security Administration audits and examinations, since they are required to be issued 1099s, which are closely reviewed for worker status.  Violations of this employment law not only result in penalties and fines to the employer but also to the employee, if he has taken deductions on a tax return filed as a self-employed individual operating a business.  Consequently, both employer and employee must carefully scrutinize and evaluate the employment situation to correctly determine the status of the working relationship.  Form SS-8, "Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding", may be filed by either the hiring company or the worker to request a determination of the status of a worker for purposes of federal employment taxes and income tax withholding.  Of course, it is always advisable to consult one's attorney and/or certified public accountant for any assistance on a legal or tax issue.

Have a tax or an accounting question?  Please feel free to submit it to William Brighenti, Certified Public Accountant, Hartford CPA Accountants.  For information and assistance on any tax and accounting issue, please visit our website:  Accountants CPA Hartford.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.  The above tax advice was written to support the promotion or marketing of the accounting practice of the publisher and any transaction described herein.  The taxpayer recipients of this offering memorandum should seek tax advice based on their particular circumstances from an independent tax advisor .
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