The proper classification of a worker is not always clear, but guidance is available to analyze each situation.
SECTION 530, REVENUE ACT OF 1978 (As amended by the Small Business Job Protection Act of 1996)
Under Section 530, a worker may be treated as an independent contractor if certain tests of reasonableness and consistency are met.
Any relationship with an independent contractor should meet the following requirements of Section 530 of the Revenue Act of 1978, as amended by the Small Business Job Protection Act of 1996. If these conditions are not met, then the IRS will use more detailed factors to determine whether workers are independent contractors or employees.
- Reasonable Basis
In order to treat a worker as an independent contractor, an employer must be able to prove that there is a reasonable basis for doing so.
Evidence of reasonable basis:
- Reliance on federal tax court decisions.
- Reliance on prior IRS audit results.
- Reliance on IRS rulings to the University.
- Other reasonable basis.
In order to meet the consistency test when classifying a worker as an independent contractor, the University must treat all similar workers as independent contractors.
- Reporting Consistency
The University must consistently file all Forms 1099-MISC for each worker earning $600 or more during the year.
STATUS UNDER COMMON LAW
Under common law, whether or not a relationship is an employer/employee arrangement or not depends on the degree of control and the degree of independence present in the relationship.
Control and Independence
Under common law, the status of a worker depends on the degree of control and independence evident in the relationship between worker and employer.
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 as to the degree of control and independence. The three 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 his work.
- Instructions - Factors considered include when, where, and how to work, and how work results are to be achieved.
- 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:
- Investment - An independent contractor generally has a significant investment in his business.
- Unreimbursed Expenses - An independent contractor is more likely than an employee to have unreimbursed business expenses, especially fixed ongoing costs.
- Services - An independent contractor may offer the same services to the public or to the relevant market.
- 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.
- 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.
- 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 of a relationship governs the worker's status, not the label.
- Benefits - If employee-like benefits are provided, then the relationship will likely be one of employer/employee.
- 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.
- 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.
- 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.
IRS TWENTY FACTOR TEST
IRS Revenue Ruling 87-41 lists twenty factors used to ascertain the degree of control and the relationship between the worker and the business.
IRS Revenue Ruling 87-41 outlines twenty factors to aid in determining the status of a relationship. It is important to remember that many of these factors could be used to indicate either an employee or an independent contractor status depending on the situation. The tests, taken as a whole, should indicate the degree of control and the degree of independence in the business relationship.
- Instructions - An employee is ordinarily required to comply with instructions about when, where, and how work is to be performed.
- Training - Employees are trained by more experienced workers, by attending meetings, or by other methods which indicate that the employer expects the work to be performed in a particular method or manner.
- Integration - If the worker's services are integrated into the business operations, it generally shows that the worker is subject to direction and control and is an employee.
- Services Rendered Personally - If a contract requires that the worker personally perform substantially all the work, then the relationship may be that of employer/statutory employee.
- Hiring, Supervising, and Paying Assistants - The fact that a worker hires, supervises, and pays assistants is one indication of an independent contractor status.
- Continuing Relationship - Employers and employees generally have a continuing relationship.
- Set Hours of Work - Setting hours of work indicates control, and therefore, an employer/employee relationship.
- Full Time Required - A worker required to work full time is under the control of an employer. An independent contractor is free to work when he or she chooses.
- Work on Employer's Premises - Working on the employer's premises suggests control over the worker. The nature of the services and the control over the worker involved determines whether or not this factor would be important.
- Order or Sequence Set - If an employer sets the order or sequence of work to be performed or retains the right to do so, then it is an employer/employee relationship.
- Oral or Written Reports - Requiring a worker to submit regular reports indicates a degree of control.
- Payment Method - An employee is usually paid by the hour, week, or month. An independent contractor may be paid by the job or straight commission.
- Payment of Business and/or Traveling Expenses - Business and travel expenses are generally paid for employees.
- Furnishing of Tools and Materials - Tools and equipment needed for the job are usually furnished to employees.
- Significant Investment - An independent contractor may invest in facilities used in performing the service. An employee generally depends on the employer to provide such facilities.
- Realization of Profit and Loss - An independent contractor has the opportunity to earn a profit from the service and has a risk of economic loss from the activity.
- Working for More Than One Firm at A time - Independent contractors may perform services for a number of businesses at one time. An employee could also work for several different businesses and be an employee of each.
- Making Service Available to General Public - An independent contractor may offer services to the general public on a regular and consistent basis.
- Right to Discharge - Employers have a right to discharge an employee, an indication of control. A contract with an independent contractor usually prevents discharge if the contractor meets the results specified in the contract.
- Right to Terminate - An employee can generally quit without incurring liability. An independent contractor is held to contract terms.
HIRING PRESENT AND FORMER EMPLOYEES
Special care should be taken when evaluating whether or not a present or former employee of the University should be hired as an independent contractor.
Present and recent former University employees should usually be paid as employees. According to IRS guidelines, a continuing relationship is one indication of an employee/employer relationship. In addition, any employment of present and former University employees as independent contractors should be evaluated carefully for other indications of employee status. In this situation, employee status might be required due to:
- The worker was previously paid as an employee to perform essentially the same type of work.
- The University pays other workers on an employee basis to perform similar tasks.