IRS 20 Factor Test – Independent Contractor or Employee?
The IRS test often is termed the “right-to-control test” because each factor is designed to
evaluate who controls how work is performed. Under IRS rules and common-law
doctrine, independent contractors control the manner and means by which contracted
services, products, or results are achieved. The more control a company exercises over
how, when, where, and by whom work is performed, the more likely the workers are
employees, not independent contractors.
A worker does not have to meet all 20 criteria to qualify as an employee or independent
contractor, and no single factor is decisive in determining a worker's status. The
individual circumstances of each case determine the weight IRS assigns different factors.
NOTE: Employers uncertain about how to classify a worker can request an IRS
determination by filing Form SS-8, “Determination of Employee Work Status for
Purposes of Federal Employment Taxes and Income Tax Withholding.” However, some
tax specialists caution that IRS usually classifies workers as employees whenever their
status is not clear-cut. In addition, employers that request an IRS determination lose
certain protections against liability for misclassification.
The 20 factors used to evaluate right to control and the validity of independent contractor
classifications include:
•
Level of instruction. If the company directs when, where, and how work is done, this
control indicates a possible employment relationship.
•
Amount of training. Requesting workers to undergo company-provided training
suggests an employment relationship since the company is directing the methods by
which work is accomplished.
•
Degree of business integration. Workers whose services are integrated into business
operations or significantly affect business success are likely to be considered employees.
•
Extent of personal services. Companies that insist on a particular person performing
the work assert a degree of control that suggests an employment relationship. In contrast,
independent contractors typically are free to assign work to anyone.
•
Control of assistants. If a company hires, supervises, and pays a worker's assistants,
this control indicates a possible employment relationship. If the worker retains control
over hiring, supervising, and paying helpers, this arrangement suggests an independent
contractor relationship.
•
Continuity of relationship. A continuous relationship between a company and a
worker indicates a possible employment relationship. However, an independent
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contractor arrangement can involve an ongoing relationship for multiple, sequential
projects.
•
Flexibility of schedule. People whose hours or days of work are dictated by a company
are apt to qualify as its employees.
•
Demands for full-time work. Full-time work gives a company control over most of a
person's time, which supports a finding of an employment relationship.
•
Need for on-site services. Requiring someone to work on company premises—
particularly if the work can be performed elsewhere—indicates a possible employment
relationship.
•
Sequence of work. If a company requires work to be performed in specific order or
sequence, this control suggests an employment relationship.
•
Requirements for reports. If a worker regularly must provide written or oral reports
on the status of a project, this arrangement indicates a possible employment relationship.
•
Method of payment. Hourly, weekly, or monthly pay schedules are characteristic of
employment relationships, unless the payments simply are a convenient way of
distributing a lump-sum fee. Payment on commission or project completion is more
characteristic of independent contractor relationships.
•
Payment of business or travel expenses. Independent contractors typically bear the
cost of travel or business expenses, and most contractors set their fees high enough to
cover these costs. Direct reimbursement of travel and other business costs by a company
suggests an employment relationship.
•
Provision of tools and materials. Workers who perform most of their work using
company-provided equipment, tools, and materials are more likely to be considered
employees. Work largely done using independently obtained supplies or tools supports an
independent contractor finding.
•
Investment in facilities. Independent contractors typically invest in and maintain their
own work facilities. In contrast, most employees rely on their employer to provide work
facilities.
•
Realization of profit or loss. Workers who receive predetermined earnings and have
little chance to realize significant profit or loss through their work generally are
employees.
•
Work for multiple companies. People who simultaneously provide services for several
unrelated companies are likely to qualify as independent contractors.
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•
Availability to public. If a worker regularly makes services available to the general
public, this supports an independent contractor determination.
•
Control over discharge. A company's unilateral right to discharge a worker suggests
an employment relationship. In contrast, a company's ability to terminate independent
contractor relationships generally depends on contract terms.
•
Right of termination. Most employees unilaterally can terminate their work for a
company without liability. Independent contractors cannot terminate services without
liability, except as allowed under their contracts.
Are Independent Contractors Employees?
Because FLSA applies only to employer-employee relationships, independent contractors
are not covered. Court decisions interpreting FLSA coverage rules require that employers
use an economic reality test in determining whether an employment relationship exists
with respect to a given worker.
Similar to the common law test, the economic reality test focuses on the degree of control
exercised by the employer as an essential factor in determining whether an employer-
employee relationship exists. While no single factor is controlling or decisive in
determining whether an employment relationship exists, the facts and circumstances that
courts and federal enforcement officials examine in deciding whether an individual is an
employee or an independent contractor are:
• the degree to which the employer controls or directs the manner in which work is
performed,
• whether the worker's opportunity for profit or loss depends on his or her managerial
skills,
• whether the worker's duties are performed for the employer on an ongoing or permanent
basis,
• whether the service performed by the worker is an integral part of the employer's
business,
• the extent of the worker's investment in equipment or materials needed to perform the
job, and
• the degree to which the worker is engaged primarily for the benefit of the employer.
The IRS considers a worker to be your employee if you have the right to control not only
what work will be done, but also how the worker will do it. If you treat a worker as an
independent contractor, but the IRS decides you have sufficient control over the worker
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to create an employment relationship, the IRS can hit you with a costly bill for the
employment taxes you should have been withholding and paying.
When deciding whether you can safely treat a worker as an independent contractor, there
are two separate tests you should consider:
The common law test; and
The reasonable basis test.
The common law test: IRS examiners use the 20-factor common law test to measure how
much control you have over the worker. These factors are reflected on IRS Form SS-8,
(this form can be downloaded at www.irs.gov)“Determination of Employee Work Status
for Purposes of Federal Employment Taxes and Income Tax Withholding.”
You can fill out the SS-8, including the facts of your relationship with the worker, and
submit it to the IRS to get a determination of whether the worker is your employee or not.
However, many companies simply use the SS-8 as a self-audit to avoid a
misclassification trap; they don't actually submit the form to the IRS.
Of course, many workers — the IRS estimates as many as 85% of all Form SS-8 filers —
submit the form to the IRS because they want to contest their treatment as independent
contractors.
But the issue of who has the right to control is often not clear-cut, and the Tax Code
doesn't define “employee.” So, the IRS developed the
“20-Factor Test” to arrive at an
answer. The IRS later refined this test—it added four new, critical factors and added
more weight to some and de-emphasized others in the original 20. You don't need to have
all the factors in your favor to be able to treat a worker as an independent, but you are
more likely to pass the common law test if the more important factors point to
independence.
According to the manual the IRS uses to train its worker classification auditors, the three
most important factors are:
Instructions to workers:
Your worker is probably an employee if you require him or her
to follow instructions on when, where, and how work is to be done. This is a very
important factor.
However, if you tell your electrician you want blue switch plate covers
instead of white, you are not exercising control to a degree that would make the person an
employee.
Job training:
If your company provides or arranges for training of any kind for the
worker, this is a sign you expect work to be performed in a certain way; therefore, the
worker is your employee. Training can be as informal as requiring the worker to attend
meetings or work along with someone who's more experienced.
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Worker's ability to make a profit or suffer a loss:
An employee may be rewarded,
disciplined, demoted, or fired depending on job performance, but only an independent
contractor can realize a profit or incur a financial loss from his or her work. In other
words, an employee will always get paid; an independent contractor, however, has a
financial stake in his enterprise.
IRS also gives high priority to the following factors:
W-2 or 1099: You report payments to independents (if they total $600 or more in a
calendar year) on Form 1099-MISC. Reporting on a Form W-2 indicates that both your
company and the worker consider the worker to be your employee.
Intent of your company and of the worker: To build a solid case, you and the worker
should sign a written agreement stating the worker is an independent contractor who will
be paid by the job or project, provide his or her own tools, etc.
Pay basis: If you pay a worker on an hourly, weekly, or monthly basis, the IRS will
consider it a sign the worker is your employee. An independent is generally paid by the
job, project, assignment, etc., or receives a commission or similar fee.
Benefits: Providing benefits other than pay are a strong indicator of employee status.
Incorporated status: Workers who are incorporated are generally considered to be
working for themselves, not as your employee.
Importance of the worker's services: If a worker provides services that are integral to
the success of your business, the worker is likely your employee.
Personal performance of services: An independent contractor should have the freedom
to hire assistants or subcontract work to other workers or firms at his or her expense (this
is where profit or loss could enter the picture). If you require the worker to perform the
work personally, that's a sign of control and therefore indicative of employee status.
Providing assistants: There's likely an employer-employee relationship if your company
hires, supervises, and pays assistants for the worker.
Ongoing relationship: The worker doesn't have to work for you continuously to be
considered an employee; it may be enough if the worker gets assignments at frequently
recurring, even if irregular, intervals.
Setting the order or the sequence of the work: If you determine what gets done when,
it indicates you control how the work is performed. Allow an independent to decide his or
her schedule, both day-to-day and for the longer term.
The reasonable basis test: While the common law test looks at the nature of the working
relationship, the reasonable basis test is based on how the courts and the IRS have
classified similar workers in your company or your industry in the past.
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The reasonable basis test is considered a “safe harbor.” That is, if you can show you had
a reasonable basis for treating a worker as an independent contractor, the IRS is
prohibited from reclassifying the worker as your employee either prospectively or
retroactively. You have a reasonable basis for treating a worker as an independent if one
or more of the following conditions exist:
A court ruling in favor of treating workers in similar circumstances as non-employees;
A ruling by the IRS (usually a Revenue Ruling) stating that similar workers are not
employees subject to employment taxes;
An IRS Technical Advice Memorandum or Private Letter Ruling issued to your
company, indicating that the particular worker isn't an employee;
A past IRS payroll audit that didn't find workers in similar positions at your company to
be employees; or
A longstanding, widely recognized practice in your industry of treating similar workers
as independent contractors.
NOTE: The Treasury Inspector General for Tax Administration has recommended that
IRS pursue legislative proposals that would mandate withholding of income taxes on
payments made to independent contractors and require monthly estimated tax payments.
TIGTA made these recommendations in order to curtail estimated tax payment
noncompliance.
The following information was taken from the IRS website in 2006
Employee or Independent Contractor?
Whether someone who works for you is an employee or an independent contractor is an
important question. The answer determines your liability to pay and withhold Federal income
tax, social security and Medicare taxes, and Federal unemployment tax.
In general, someone who performs services for you is your employee if you can control what
will be done and how it will be done.
The courts have considered many facts in deciding whether a worker is an independent
contractor or an employee. These facts fall into three main categories:
• Behavioral Control – Facts that show whether the business has a right to direct
and control. These include:
o Instructions - an employee is generally told:
1. when, where, and how to work
2. what tools or equipment to use
3. what workers to hire or to assist with the work
4. where to purchase supplies and services
5. what work must be performed by a specified individual
6. what order or sequence to follow
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o Training – an employee may be trained to perform services in a particular
manner.
• Financial Control – Facts that show whether the business has a right to control the
business aspects of the worker’s job include:
o The extent to which the worker has unreimbursed expenses
o The extent of the worker’s investment
o The extent to which the worker makes services available to the relevant
market
o How the business pays the worker
o The extent to which the worker can realize a profit or loss
• Type of Relationship – Facts that show the type of relationship include:
o Written contracts describing the relationship the parties intended to create
o Whether the worker is provided with employee-type benefits
o The permanency of the relationship
o How integral the services are to the principal activity
* See next page for an example of an Independent Contractor Agreement. The Agreement
is provided as an example document, A-Plus Benefits, Inc. does not endorse the
document nor act as legal counsel for its’ clients.
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Example: Independent Contractor Agreement
AGREEMENT BETWEEN “Name of Organization” (hereinafter “Company”) located at
[address] and [name of contractor], an Independent Contractor ("Independent
Contractor"). The Independent Contractor shall be identified as follows:
Name: Name contractor (hereinafter “Independent Contractor)
Type of Entity:
__ Individual
__ Sole proprietorship
__ Partnership
__ Corporation
Address: ______________________________________________
City/State/ZIP: _________________________________________
Business Telephone: ____________________________________
Social Security or Employer Identification Number:____________________
IN CONSIDERATION of the promises and mutual covenants and agreements contained
herein, the parties agree as follows:
Work to Be Performed
Company desires that the Independent Contractor perform, and the Independent
Contractor agrees to perform, the following work:
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________
Term of Agreement
The services called for under this Agreement shall commence on [date] and terminate on
[date].
Technical Direction
The Independent Contractor shall receive technical direction only from [name] or his or
her designee, as authorized in writing.
Terms of Payment
Company shall pay the Independent Contractor according to the following terms and
conditions:
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________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Reimbursement of Expenses
Company shall not be liable to the Independent Contractor for any expenses paid or
incurred by the Independent Contractor unless otherwise agreed to in writing.
Federal, State, and Local Payroll Taxes
Company shall not withhold or pay federal, state, or local income taxes or payroll taxes
of any kind on behalf of the Independent Contractor or the employees of the Independent
Contractor. Company shall not treat the Independent Contractor as an employee with
respect to the services performed hereunder for federal, state, or local tax purposes.
Notice to Independent Contractor About Its Tax Duties and Liabilities
The Independent Contractor understands that he or she is responsible to pay, according to
law, the Independent Contractor's federal and state income taxes, and that Company is
not withholding or paying any portion of Independent Contractor's taxes. If the
Independent Contractor is not a corporation, the Independent Contractor further
understands that the Independent Contractor may be liable for self-employment (Social
Security) tax, to be paid by the Independent Contractor according to law.
Responsibility for Workers' Compensation
No workers' compensation insurance shall be obtained by Company covering the
Independent Contractor or employees of the Independent Contractor. The Independent
Contractor shall comply with the workers' compensation law concerning the Independent
Contractor and the employees of the Independent Contractor.
Termination of Agreement
This Agreement may be terminated at any time by Company or the Independent
Contractor, by written notice to the other party. Notice shall be deemed to have been
sufficiently given either when served personally or when sent by first-class mail
addressed to the parties at the addresses set forth in this Agreement. Company shall not
be liable for, nor shall the Independent Contractor be liable to perform, any services or
expenses incurred after the receipt of notice of termination
Independent Contractor Status
The Independent Contractor expressly represents and warrants to Company that (1) he or
she is not and shall not be construed to be an employee of the company and that his or her
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status shall be that of an independent contractor solely responsible for his or her actions
and inactions; (2) the Independent Contractor shall act solely as an Independent
Contractor, not as an employee or agent of Company; and (3) the Independent Contractor
is not authorized to enter into contracts or agreements on behalf of Company or to
otherwise create obligations of Company to third parties.
Assignability
This Agreement shall not be transferred or assigned, in whole or in part, by the
Independent Contractor without the prior written consent of Company.
Choice of Law
Any dispute under this Agreement, or related to this Agreement, shall be decided in
accordance with the laws of the state of Utah.
Agreement
This Agreement supersedes all prior oral or written agreements, if any, between the
parties and constitutes the entire agreement between the parties. The Agreement cannot
be changed or modified orally. This Agreement may be supplemented, amended, or
revised only in writing by agreement of the parties.
Confidential Matters and Proprietary Information
The Independent Contractor recognizes that during the course of contract performance he
or she may acquire knowledge or confidential business information or trade secrets. The
Independent Contractor agrees to keep all confidential information in a secure place and
further agrees not to publish, communicate, divulge, use, or disclose, directly or
indirectly, for his or her own benefit or for the benefit of another, either during or after
contract performance, any confidential business information or trade secrets. Upon
termination or expiration of this Agreement, Independent Contractor shall deliver all
records, data, information, and other computer media or documents produced or acquired
during the performance of this Agreement and all copies thereof to Company. Such
material shall remain the property of Company. This obligation of confidence shall not
apply with respect to information that (1) is available to the Independent Contractor from
third parties on an unrestricted basis; or (2) is disclosed by Company to others on an
unrestricted basis.
Conflicts of Interest
The Independent Contractor shall not act as an agent for, consultant to, or as an officer,
employee, or other representative of any subcontractor or supplier to Company, or serve
in any of the foregoing capacities for any of Company’s competitors or prospective
competitors, without giving prior written notification to Company. The Independent
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Contractor hereby warrants that there is no conflict of interest between the Independent
Contractor's other employment, if any, or other contracts, if any, and the activities to be
performed hereunder. The Independent Contractor shall advise Company if a conflict of
interest arises in the future.
Inventions, Patents, Trademarks
The terms "work," "trademark," and "invention" include anything created for Company
by the Independent Contractor, whether alone or with others, and whether those others be
independent contractors, employees, or agents of Company.
1. The term "work" means any and all writings, designs, models, drawings,
photographs, physical property, reports, etc., that are protectable under Title 17 of the
U.S. Code.
2. The term "trademark" means any name, word, phrase, logo, design, or other
graphic depiction generated during the performance of this Agreement that is or can be
used to describe either a product or service of Company.
3. The term "invention" means any designs, processes, inventions, or discoveries
that may be patentable or otherwise protectable under Title 35 of the U.S. Code.
Work Made for Hire
During the performance of this agreement, the Independent Contractor may create certain
works for Company that may be copyrighted under the laws of the United States. To the
extent that any such works are created, the Independent Contractor will be considered to
have created a work made for hire as defined in 17 U.S.C. § 101, and Company shall
have the sole right to the copyright. If any work created by the Independent Contractor
does not qualify as a work for hire, the Independent Contractor agrees to assign his or her
right in the work to Company, as provided below.
Title to Works, Trademarks, and Inventions Produced
It is understood and agreed that the entire right, title, and interest throughout the world to
all works, trademarks, and/or inventions that are conceived of, prepared, procured,
generated, or produced, whether or not reduced to practice, by the Independent
Contractor, either solely or jointly with others during the course of, in connection with, or
as related to the performance of this Agreement, shall be and hereby are vested and
assigned by the Independent Contractor to Company.
The Independent Contractor agrees to execute any and all documents prepared by
Company and to do all other lawful acts as may be required by Company to establish,
document, and protect such rights.
The Independent Contractor has acquired or shall acquire from each of his or her
employees, consultants, and subcontractors, if any, the necessary rights to all such works,
trademarks, and inventions produced by such employees, consultants, and subcontractors,
within the scope of their employment by the Independent Contractor in performing
services under this Agreement. The Independent Contractor shall obtain the cooperation
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of each such employee to secure to Company or its nominees the rights Company may
acquire in accordance with the provisions of this clause.
Reports
The Independent Contractor, when directed, shall provide written reports with respect to
the services rendered hereunder.
Security Regulations
The Independent Contractor shall comply with all applicable security regulations of
Company.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed
as of [date].
INDEPENDENT CONTRACTOR
By _________________________________________________
Print name ___________________________________________
Title (if applicable) ____________________________________
COMPANY
By _________________________________________________
Print name ___________________________________________
Title (if applicable) ____________________________________
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