Independent Contractor or Employee?

This question comes up frequently. The answer has implications for both parties. If a worker is an employee, they are eligible for whatever benefits are offered by the company including health insurance, vacation pay, and others. The employer pays a match for social security and Medicare taxes. If the worker is an independent contractor, they pay self employment taxes which are the equivalent of both the employee’s social security and Medicare taxes plus the employer match. They are not eligible for employer provided benefits. On the other hand, there may be some additional expenses that an independent contractor can deduct directly against his gross earnings that either are not available to an employee or must be taken “below the line” as itemized deductions subject to a 2% of adjusted gross income reduction and phase out.

The relevant facts used in deciding whether a worker is an independent contractor fall into three main categories: behavioral control; financial control; and relationship of the parties. In each case it is important to consider all the facts – no single fact provides the answer. The weights assigned to each factor varies depending on the facts. The IRS in Revenue Ruling 87-41 outlined 20 factors to consider. Due to the changing nature of the work place since this ruling was issued, some of these factors must be considered very cautiously.

Let’s consider the factors in the three main categories. These are not the same order as discussed in Revenue Ruling 87-41. The number that appears after the factor is the number from that ruling. The order does not indicate that more or less weight should be assigned to that factor.

Behavorial Control
These factors show whether there is a right to direct or control how the worker does the work. The business does not have to actually direct or control the way the work is done – as long as it has the right to do so.

Instruction (1) – Extensive instructions on how work is to be done suggests employee relationship.
Training (2) – If the business provides worker with training about required procedures and methods this suggest an employee relationship.
Integration (3) When the success of a business depends upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
Services rendered personally (4) – If the services must be rendered personally, that indicates control.
Hours of work (7) – Establishment of set hours of work indicates control.
Full time required (8) – If the worker must devote substantially full time to the business that indicates control.
Work on employer premise (9) – That suggest control.
Order or sequence set (10) – If the worker must perform services in the order set by the business, that is an indication of control.
Oral or written reports (11) – A requirement to submit reports to the person for whom the services are done indicates a degree of control.
Furnishing of tools and materials (14) – The fact that a business furnishes these items tends to show an employee relationship.
Hiring, Supervising, and paying assistants (5) – If the business does these things, that generally shows control over the workers on the job.

Financial Control
These facts show whether there is a right to direct or control the business part of the work.

Significant investment (15) – If the worker has one, that may indicate they may be a contractor.
Expense (13) – If the worker is not reimbursed for some or all business expenses, this may indicate status as a contractor.
Opportunity for profit or loss (16) – A worker that can realize a profit or loss as a result of the work indicates that they are a contractor.
Payment by the hour, week, or month (12) – These tend to indicate an employment status as contractors tend to be paid by the job.
Working for more than one firm at a time (17) – This indicates the worker is a contractor.
Making services available to the general public (18) - This indicates the worker is a contractor.

Relationship of the Parties
These are facts that illustrate how the business and the worker perceive their relationship.

Continuing relationship (6) – A continuing relationship indicates an employee status.
Right to discharge (19) – The right to discharge a worker is a factor that shows the worker is an employee.
Right to terminate (20) – If the worker has the right to end his relationship at any time they wish without liability, this indicates an employee status.
Written contract – Such a contract may show the intentions of both parties. When the analysis of the other factors makes it difficult to decide what the relationship is, this can be a critical factor.
Employee benefits – Receiving benefits indicates the worker is an employee.

About the Author - Duane B. Schlereth

Duane has over 37 years experience in several areas of public accountancy. He spent six years in the audit department of Price, Waterhouse in Edmonton, Canada, passing the Canadian Chartered Accountants' examination in 1976. His background includes significant experience with businesses, not-for profit agencies, and City and County governments from auditing services to consulting services.

Duane was the winner of the Georgia Society of CPA's Gold Key for the highest marks on the 1984 CPA Exam and the winner of the Elijah Watt Sells Award for one of the top 120 marks in the nation out of 70,000 on the 1984 CPA Exam. Duane is a member of the Governmental Accounting Committee of the Georgia Society of CPA's and is past president of the Northeast Georgia Chapter of the Georgia Society of CPA's. He has his certification in the Governmental and Non-Profit Certificate of Educational Achievement program. He is a member of the Government Finance Officers Association, serving on the Certificate of Achievement for Excellence in Financial Reporting Special Review Committee and the Distinguished Budget Presentation Awards program review committee. He is also a member of the Georgia Government Finance Officers Association.

Duane has written and taught numerous seminars on "How to Prevent Fraud". He is past treasurer of the local Red Cross chapter, and past Vice-President of Elachee Nature Science Center. He is a past president of the Lake Lanier Rowing Club as well as a member of their race team.

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