The Control Test: The IRS Standard
The Internal Revenue Service (IRS) standard is used to determine whether a worker is an employee for federal tax purposes. Historically, the IRS Standard was the 20-Factor Test, but the IRS has since grouped the 20 factors into three primary categories of the worker's control or independence:
- Behavioral control. Behavioral control refers to whether the company controls or has the right to control how the worker does the work.
- Financial control. Financial control refers to whether the company controls the business aspects of the worker's job.
- The type of relationship. The type of relationship refers to how the parties perceive their relationship.
Companies must evaluate the entire relationship and consider all of these factors in determining whether a worker is an employee or an independent contractor. No single factor or combination of factors controls. Additionally, factors relevant to one working relationship may not be relevant in another situation.
According to the IRS, the "keys" are to:
- Look at the entire relationship.
- Consider the degree or extent of the right to direct and control.
- Document each of the factors used to make the determination.
Evaluating an Independent Contractor
All tests for independent contractor status are based on various factors, and no single factor is dispositive of a worker's classification. Before engaging an independent contractor, companies should evaluate the contractor's experience and ability to complete the project and whether the contractor can satisfy certain indicia of an independent contractor relationship.
Companies should make and keep copies of contractor documents that will support an independent contractor classification if it is later challenged.
Operating as a Business Entity
The DOL has stated that whether the worker has incorporated a business or is licensed by a state or local agency has little influence on the worker's status as an employee or independent contractor. However, companies should gather information and documents concerning the worker's business to support an independent contractor classification, including:
- A certificate, license, or other federal, state, or local evidence of the formation or registration of a business entity (including a limited liability company, corporation, partnership, or sole proprietorship). Confirm that the certificate, license, or registration is current and issued to the contractor or their business.
- The contractor's federal Employer Identification Number (EIN) and its state or local equivalent. Federal EINs are the corporate equivalent of a Social Security number and are issued to every organization by the IRS. State and local governments may give similar unique numbers to identify the organization for tax and other purposes. (Sole proprietorships generally use the owner's Social Security number.) Companies are responsible for backup withholding for any independent contractor that does not provide an EIN or provides an incorrect EIN.
- Whether the contractor operates their business from their home or another location (for example, rental or lease agreements).
- Whether the contractor has a website or a business phone, fax, or email address.
- Whether the contractor has separate business bank accounts.
- Professional licenses or certificates the contractor or their business holds.
- Insurance the contractor or their business holds in connection with their work, including limits (general liability and workers' compensation insurance).
- Tax documents, including Schedule C, Profit or Loss From a Business. Confirm the contractor has paid federal, state, and local taxes.
- A description of tools, equipment, vehicles, facilities, and other property the contractor owns (or rents) and uses for their work.
- The number of employees the contractor employs (including, for example, copies of the contractor's unemployment insurance information).
- Whether the contractor has previously filed for workers' compensation or unemployment insurance benefits.
Advertising Services to the Public
Independent contractors commonly advertise and offer their services to the relevant market as they choose. Working for other clients or customers can demonstrate the contractor's lack of economic dependence on any one company engaging their services. Companies evaluating an independent contractor should collect evidence of the contractor offering their services to other individuals or entities, including:
- Social media accounts dedicated to the contractor's business, such as Facebook, Twitter, Pinterest, LinkedIn, or Instagram pages or accounts.
- Stationery, including letterhead, envelopes, business cards, and novelty advertising items such as key chains, calendars, and pens.
- Requests for payment for work performed for others, including bids, bills, and invoices.
- References, testimonials, and customer reviews.
- Evidence of payment from other customers or clients, including Form 1099-MISC, for example.
Controlling the Work
Control is a common factor among most tests for independent contractor status. Companies should confirm in advance that the contractor is responsible for:
- Hiring or delegating work to their employees or assistants.
- Setting hours and days of work for themselves and their employees.
- Complying with the required minimum employment standards under federal, state, and local law applicable to their employees, including wage and hour and immigration control requirements.
- Maintaining any licenses, certificates, and permits required for the project.
- Setting the price for services and being paid by the project, not by the hour.
- Owning or renting from a third party the tools, equipment, workspace, and supplies required for the project.
- Controlling how the work is performed. (The company engaging the contractor's services controls only the end product.)
Engaging an Independent Contractor
A company's obligation to ensure the satisfaction of the independent contractor classification requirements continues beyond contractor selection. Throughout a contractor's project or term, the company should:
- Use a separate contractor agreement to establish the terms of the working relationship.
- Avoid using former employees as independent contractors or having independent contractors do the same work as employees.
- Avoid using independent contractors to perform work that is integral to the business. For example, a graphic designer generally may be an independent contractor paid to design a shoe company's logo, but not an independent contractor paid to do graphic design work for a graphic design firm.
- Require independent contractors to complete a Form W-9, not Form W-4 used for employees
- Do not complete a Form I-9 for independent contractors.
- Do not allow independent contractors to manage company employees. Avoid independent contractor participation in the hiring, discipline, or termination of company employees.
- Pay contractors by the project or by an agreed-on flat fee at regular intervals, not by the hour, week, or month. Companies should require contractors to submit invoices and should pay those invoices from accounts payable, not payroll. Companies must issue a Form 1099-MISC to any independent contractor paid $600 or more in a particular year.
- Do not reimburse independent contractors for business expenses. An independent contractor operates a business and is responsible for expenses. Contractors should factor business expenses such as travel, supplies, and tool rental into the project's cost. A contractor's ability to manage the costs and set the fee for their services supports a finding that the contractor is economically independent of the company.
- Do not provide contractors with employee-type benefits like health insurance, paid vacation, paid holidays, sick leave, and retirement benefits. Require contractors to waive their right to those benefits affirmatively.
- Do not schedule hours or days of work for contractors or their employees.
- Avoid requiring uniforms, name tags, grooming standards, and similar workplace requirements typically imposed on employees.
- Make ID badges and building access cards for independent contractors different from the ones issued to employees.
- Issue separate guidelines for independent contractors, vendors, and other third parties instead of providing them with a copy of the employee handbook.
- Limit training (if any) to information about working on the employer's premises, including entry and exit procedures, access to computer systems, and the anti-harassment policies applicable to independent contractors, vendors, and other third parties.
- Keep independent contractor files with vendor files, not employee files.
- Do not provide independent contractors with company business cards.
- Do not give independent contractors company job titles.
- Deal with performance problems as contract modification or breach issues, not as disciplinary issues. Do not conduct performance evaluations for independent contractors. Do not involve Human Resources in the working relationship with independent contractors.
- Determine if the company's competitors classify similar workers as employees instead of independent contractors.
- Do not assume industry practice satisfies the requirements for independent contractor classification.
- Use caution when policies, such as headcount freezes, could result in managers using independent contractors to fill open positions.
- Regularly audit the company's independent contractor arrangements and template agreements.