One of the most common questions I have been asked recently is how to determine whether a worker is considered an independent contractor (thereby needing to complete a 1099) or an employee (W-2). Most cases are fairly cut and dry, but there are times where this can be a grey area. The temptation is to classify an individual as a contractor because of savings in employment and unemployment taxes, worker’s compensation insurance, and to avoid state and local tax reporting. But how does the IRS view this issue?
Most simply, the IRS looks at 3 primary factors that are based on the degree of control versus independence:
- Behavioral: Does the company control, or have the right to control, how the worker does his or her job? Less control=more likely a contractor.
- Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) More financial control=more likely an employee.
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? A contract and end date for the job=more likely a contractor.
If the above list does not clear things up, then the IRS also provides 20 questions to determine the level of control.
1. Must the individual take instructions from your management staff regarding when, where, and how work is to be done?
2. Does the individual receive training from your company?
3. Is the success or continuation of your business somewhat dependent on the type of service provided by the individual?
4. Must the individual personally perform the contracted services?
5. Have you hired, supervised, or paid individuals to assist the worker in completing the project stated in the contract?
6. Is there a continuing relationship between your company and the individual?
7. Must the individual work set hours?
8. Is the individual required to work full time at your company?
9. Is the work performed on company premises?
10. Is the individual required to follow a set sequence or routine in the performance of his work?
11. Must the individual give you reports regarding his/her work?
12. Is the individual paid by the hour, week, or month?
13. Do you reimburse the individual for business/travel expenses?
14. Do you supply the individual with needed tools or materials?
15. Have you made a significant investment in facilities used by the individual to perform services?
16. Is the individual free from suffering a loss or realizing a profit based on his work?
17. Does the individual only perform services for your company?
18. Does the individual limit the availability of his services to the general public?
19. Do you have the right to discharge the individual?
20. May the individual terminate his services at any time?
What is interesting about this issue is that there is very little, if any, case law from the IRS’s perspective. Most case law relates to workers compensation and unemployment issues. In those cases, the courts have rule that some control is allowable when classifying an individual as a contractor.
Odds are you now have more questions than answers regarding the proper status of your team. Give us a call and we can review your business’ situation to help you to navigate the grey area of contractor versus employee.