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. Consult with your CPA.
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 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.
- 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.
The Economic Realities Test
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
- 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 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 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.
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.
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:
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.
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
When hiring anyone, consultation with an attorney or a CPA or both is highly recommended. This article is intended for educational purposes only.