It's Not Your Decision!

In the working world, the distinction between an independent contractor and an employee is crucial. Employees enjoy protections and advantages under a number of federal and state laws, which do not extend to independent contractor status. Among these are unemployment benefits and workers compensation, minimum wage and overtime protections, payment of payroll and income taxes by the employer and anti-discrimination laws.

Who decides whether a worker qualifies as an employee or independent contractor? Usually, it is not the parties to the arrangement. The government decides, and you may be surprised to learn that each government agency which deals with this workplace issuefor tax, benefits or other purposes -- tends to have its own standard or legal test for making this determination. No two tests are the same!

Today, increasingly popular (but nontraditional) jobs in which workers telecommute or job-share may lack employee status. Some workers may consider this an acceptable tradeoff for the flexibility or status these positions offer.

Control of the worker

The inquiry central to all tests is the degree of control the business has the right to exercise over the activities of the worker. When a business exercises sufficient control over the means by which the work is done as well as the results of the work, it is likely that the worker will be classified as an employee rather than an independent contractor. Beyond the control question, each government body -- federal agencies as well as court systems -- which considers this issue has a specialized set of criteria it applies.

For tax withholding purposes

Much is riding on the proper classification of each worker by a business. Laws administered by the IRS make employers responsible for the income-withholding obligations on employee compensation. This obligation does not exist with respect to independent contractors, who are responsible for paying their own taxes. The business has withholding obligations with respect to employment (FICA and FUTA) taxes, also.

The IRS uses a list of 20 different factors to determine whether the requisite degree of control exists to classify a worker as an employee (see sidebar). According to the IRS, each of these factors tends to show either behavioral control, financial control or the type of business relationship which evidences employee status. In theory, the IRS considers each determination on a totality of circumstances basis; no one factor will control the determination. In practice, however, court cases reviewing these determinations have found that the frequency of payment (where the payment is made hourly, weekly or monthly) has a major impact, allowing the IRS conclusion that the worker in question is an employee.

For benefits purposes

The U.S. Department of Labor (DOL) administers the Fair Labor Standards Act (FLSA), legislation originally passed during the Depression to protect workers from oppressive working conditions. This is the law that provides a minimum wage and a ceiling on the work week for covered employees, among other things. Unlike the IRS, the DOL uses an economic activity test for the purpose of ascribing employee status under the FLSA. What this boils down to is determining whether, as a matter of economic reality, the worker is dependent on the company for a living. If so, DOL is likely to conclude that the worker is an employee.

Although control remains an important factor in this test, the DOL inquiry focuses on the economic aspect of the relationship between worker and business: Who has the opportunity to profit and the risk for loss, whether the worker has made any significant investment in equipment used in the work and whether the economic function performed by the worker is an essential part of the business.

For liability purposes

State and federal courts typically use a common-law test to determine the employment status of a worker in a variety of cases, including general liability issues and specialized discrimination and employee benefits claims. Under this common-law standard, an employee is one whose role is understood within the conventional master-servant relationship, subject in all respects to the orders and control of the employer.

The distinction between contractor and employee is particularly important in tort (or civil wrongs) liability. Generally, the employer is liable for wrongs done by an employee within the scope of the employment. Employers do not incur this liability with respect to the actions of independent contractors, who bear the risk of exposure themselves.

-Gavin M. Ganzkow serves as Corporate Counsel for IAS, is a graduate of the University of Pennsylvania Law School, and has more than 10 years of experience in commercial law.

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The IRS 20-Factor Test (taken from IRS Revenue Ruling 87-41)

1. Whether worker must comply with instructions
2. Training worker receives
3. Integration in business operations
4. Services rendered personally
5. Business hires, supervises, pays other assistants
6. Continuing relationship
7. Set hours of work
8. Full time required
9. Work performed on premises
10. Services performed in set order or sequence
11. Requirement of oral or written reports
12. Payment by hour, week or month
13. Payment of business expenses
14. Worker furnished with tools or equipment
15. Any significant investment by worker in facilities
16. Whether worker realizes a profit or loss
17. Whether worker performs services for more than one business
18. Worker services available to general public
19. Right to discharge (business)
20. Right to terminate relationship (worker)

Additional information on the employee/independent contractor distinction (as the IRS sees it) may be found in IRS Publication 15A, Employer's Supplemental Tax Guide; Employee or Independent Contractor?, available on the IRS Web site, http://www.irs.gov.

On request, the IRS will also determine whether any specific worker is an employee. Complete and file Form SS-8, "Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding."

For more information and additional money strategy visit: http://www.TheMoneyExpert.com and pick up a FREE subscription to FREE MONEY TIPS, The Worlds Leading Money Strategy Newsletter

2006 International Administrative Services, Inc.