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Independent Contractors and the IRS

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Under common law, the status of a worker depends on the degree of control and independence evident in the relationship between worker and employer.

IRS Revenue Ruling 87-41 outlines 20 factors to aid in determining the status of a relationship. The tests, taken as a whole, should indicate the degree of control and the degree of independence in the business relationship.

According to Internal Revenue Service Publication 15, Circular E, "Anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed."

Publication 15A, Employer's Supplemental Tax Guide, further defines the rules under common law. "....The relationship of the worker and the business must be examined. All evidence of control and independence must be considered. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered."

Publication 15A defines three categories of facts that provide evidence about the degree of control and independence. The 3 categories, including examples of the types of evidence demonstrating the degree of control and independence of each are:

Behavioral Control

The type and degree of instruction and training given to the worker shows whether or not the business has a right to direct and control how the worker does the work assigned.

  1. Instructions - Factors considered include when, where, and how to work, and how work results are to be achieved.
  2. Training - The type of training given to a worker can demonstrate the degree of control in the relationship. Training a worker to perform services in a particular manner is one factor in an employer/employee relationship.

Financial Control

The following factors are considered when evaluating whether or not the employer has a right to control the business aspects of the worker's activities:

  1. Investment - An independent contractor generally has a significant investment in his/her own business.
  2. Unreimbursed Expenses - An independent contractor is more likely than an employee to have unreimbursed business expenses, especially fixed ongoing costs.
  3. Services - An independent contractor may offer the same services to the public or to the relevant market.
  4. Method of Payment - An employee is likely to be paid by the hour, week, or month. An independent contractor is normally paid by the job.
  5. Opportunity for Profit or Loss - An independent contractor usually has the opportunity to make a profit from the relationship and also runs the risk of loss.

Relationship Between the Parties

In considering whether an employer/employee relationship exists, the intent of the parties involved and how they perceive their relationship is one important factor. Intent of the parties, however, will not override other factors that clearly suggest an employer/employee relationship.

  1. Intent - Usually a business and an independent contractor agree on terms through written contracts, but a contract is not necessarily proof of a business/independent contractor relationship. According to Internal Revenue Service policies, the substance, not the label, of a relationship governs the worker's status.
  2. Benefits - If employee-like benefits are provided, then the relationship will likely be one of employer/employee.
  3. Discharge/Termination/Resignation - The ability of the parties to terminate their relationship may be used to evaluate the status of the worker. Although distinctions in this area are blurred due to modern business practices and court decisions, the ability of a business to refuse payment for unsatisfactory work does continue to provide evidence of independent contractor status.
  4. Permanency of the Relationship - An employer/employee relationship is usually of a permanent or indefinite nature. An independent contractor may be engaged for a specific project or period. A long-term relationship may exist with an independent contractor when contracts are for long periods or are renewed due to superior service or lack of alternative service providers.
  5. Regular Business of the Company - An employee generally performs work involved with a key aspect of the regular business of the company. In considering this factor, courts will also look at whether or not the employer is likely to have the right to direct and control the services performed.

Independent Contractor/Employee Checklist

Purchases from State Employees Guidance