Employee vs. Independent Contractor

Dear Client:

We are often asked by employers if they can classify one or more of their workers as independent contractors rather then as employees. In most cases, the employer is seeking to eliminate the payroll tax burden associated with an employees pay. In some cases, the workers also believe that they are better off classified as an independent contractor.

Our experience has been that you can't create a "relationship" that does not exist. Even if the employee, as we have seen is a few cases, actually creates a corporation for himself and/or agrees in writing regarding his relationship with his employer, the Internal Revenue Service (IRS) may reclassify the worker's status.

WHAT HAPPENS WHEN AN INDEPENDENT CONTRACTOR IS RECLASSIFIED?

The cost of improperly classifying workers as independent contractors can be quite high. If the IRS and other federal and state agencies determine that the worker is actually an employee, they will require the business to reclassify the worker. THEN, the business may incur:
bulletLiability for back pay for two to three years' overtime under wage and hour laws.
bulletLiability for employer's FICA and FUTA taxes.
bulletLiability for a portion of the employees FICA taxes and withheld federal income tax.
bulletPenalties up to 25% or more on the above liabilities
bulletInterest on taxes and penalties
bulletRisk of losing deductibility of some past contributions to a qualified benefit plan. The lost deduction would create company taxes, penalties and interest. The company and participants then owe additional FICA and FUTA taxes, penalties and interest.
bulletUncertain effect on group benefit plans, worker's compensation plans. or fringe and mandatory benefits plans, such as vested vacation or family leave

To help determine whether an individual is an employee under the common-law rules, the IRS has identified 20 common-law factors. These factors indicate whether sufficient control exists to result in employee classification. The 20 factors can be both frustrating to use and a bit dangerous. First, they often assume that Independent Contractors are all like physicians, while employees are all like assembly line workers. That simply is not true. Second, the 20 common-law factors are handpicked by the IRS.

LIST OF 20 COMMON-LAW FACTORS:

  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.
  2. Training. Training a worker by requiring an experienced employee to work with the worker indicates that the employer wants the services performed in a particular method or manner.
  3. Integration. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control
  4. Services Rendered Personally. If the services must be rendered personally, presumably the employer is interested in the methods used to accomplish the work as well as in the result.
  5. Hiring, Supervising, and Paying Assistants. If the employer hires, supervises and pays assistants, that factor generally shows control over the workers on the job.
  6. Continuing Relationship. A continuing relationship between the worker and the employer indicates that an employer-employee relationship exists.
  7. Set Hours of Work. The establishment of set hours of work by the employer is a factor indicating control.
  8. Full Time Required. If the worker must devote substantially full time to the business of the employer, such employers have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. 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 employer, that factor suggest control over the worker.
  10. Order or Sequence Set. If a worker must perform services in the order or sequence set by the employer, that factor shows that the worker is not free to follow the worker's own patterns of work.
  11. Oral or Written Reports. A requirement that the worker submit regular or written reports to the employer indicates a degree of control.
  12. Payment by Hour, Week, Month. Payment by the hour, week or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of the job.
  13. Payment of Business and/or Traveling Expenses. If the employer ordinarily pays the worker's business and/or traveling expenses, the worker is ordinarily an employee.
  14. Furnishing of Tools and Materials. The fact that the employer furnishes significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.
  15. Significant Investment. If the worker invest in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor.
  16. Realization of Profit or Loss. A worker who can realize a profit or suffer a loss as a result of the worker's services is generally an independent contractor, but the worker who cannot is an employee.
  17. Working for More Than One Firm at a Time. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.
  18. Making Service Available to General Public. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
  19. Right to Discharge. The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer.
  20. Right to Terminate. If the worker has the right to end his or her relationship with the employer at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship.

Very truly yours,

KOLITA & COMPANY

Certified Public Accountants

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