I’ve previously discussed the importance of properly classifying workers as employees or independent contractors. The IRS previously used a 20-factor test in determining whether workers were employees or independent contractors, which the agency has since consolidated into an eleven-factor test, which are:
1) Instructions the business gives to the worker (such as where to do the work [like the business’ office], what tools or equipment to use, or what sequence or procedure to use in doing the work) — the more detailed the instructions, the more likely the worker is actually an employee
2) Training the business gives the worker — employees typically receive training from the business, whereas independent contractors obtain their own training
3) The extent to which the worker has unreimbursed business expenses — in particular, fixed ongoing costs whether or not work is being done; independent contractors are not generally reimbursed for expenses
4) The extent of the worker’s investment — independent contractors often make investments into their worker, such as equipment purchases or the renting of workspace
5) The extent to which the worker makes services available to the relevant market — independent contractors should regularly advertise their services to the broader market and have multiple clients at once or over a period of time
6) How the business pays the worker — independent contractors are paid on invoice, whereas employees are paid at regular intervals (e.g. biweekly)
7) The extent to which the worker can realize a profit or loss — independent contractors can realize a profit or loss from work performed for a business, whereas employees don’t contribute to the cost of doing business and are paid a wage or salary regardless of the work being done
8) Written agreements describing the relationship the parties intended to create — for example, did the parties use an independent contractor agreement? Was the worker given an employee manual? (it should be noted that although the actual nature of the relationship is what really matters, in particularly close cases the intent of the parties can factor in)
9) Whether the business provides the worker with employee-type benefits — such as insurance, pension, vacation, and sick time
10) The permanency of the relationship — if the relationship is commenced with the understanding that it will continue indefinitely or be permanent, rather than terminate upon the completion of a project, it points to an employer-employee relationship
11) The extent to which services performed are a key aspect of the regular business of the company — if the worker is providing critical services or the company is presenting the work as the company’s own, it is more likely that the company is directing the activity of the worker like that of an employee
It is important to note that not every factor has to tip in the direction of indicating an employer-employee relationship, nor is there really a bright line for that can be crossed for every factor — even one factor can overwhelmingly point the analysis one way or the other, so it doesn’t work to try to “beat the system” by structuring the relationship in certain ways in order to avoid classifying workers as employees. Moreover, as previously stated the concern is not what the parties consider the relationship to be, but rather what the nature of the relationship actually is in practice, so it is even possible to unwittingly treat an independent contractor like an employee.
Here are a few tips to better ensure that you don’t accidentally end up treating independent contractors like employees (and risking a reclassification by the IRS), most of which can be gleaned from the 11-factor test above:
1: Issue a Form 1099
2: Did you issue a Form 1099? Stop reading this and go issue a Form 1099 (then come back and read the rest of this article). Not issuing one is a very serious oversight that at worst could be a fatal error or at best lead to additional scrutiny from auditors.
3: Avoid giving too many detailed instructions to contractors, in particular concerning having the contractor work at your place of business (unless it is necessary to the project) or working certain hours (although you can set deadlines or milestones).
4: It is better to hire contractors that have or have had other clients; if you are their first client, make sure they are actively advertising their services. In the same vein, it is ideal if the contractor is performing their services as a corporation, LLC, or DBA, although some contractors obviously operate as sole proprietors under their own name, so it is not a necessity.
5: This one seems a little obvious, but don’t give or have contractors follow your employee handbook, or refer to them or let them refer to themselves as employees of your company.
6: Make sure you’re getting invoices from your contractors, and aren’t simply paying them on a regular basis.
At a basic level, an independent contract is a business you hire to handle a task or project for your business — contractors should be treated accordingly. If you do have a serious question regarding a course of action to be taken with a contractor, you should certainly consult with your attorney or tax advisor.