DO I HAVE A Contractor OR employee ? Tests that matter and why you should care.

Your business is growing and it can not grow alone.  You need help and you don't know the difference between an independent contractor and an employee or why any regulatory officials (IRS and Massachusetts Labor and Workforce Dev.) would even care what you call them.

Here is the short of it. 

There is no black a white definition under fed or state law, it is a "facts and circumstances decision and the burden of proof is on you.  Basically, if the person you are giving paid work to has their own business, does the same type of work for others, and does not require a lot of training, most businesses would call that an independent contractor.  These contractors are often responsible for themselves and are able to handle their own affairs like paying bills on-time and getting insurance if they need it.  However, some states like Massachusetts have very strict requirements that makes your business responsible for them and opens the door for them to penalize you for not buying insurance or funding their programs.

If your "help" has the professional and capitalistic life skills of a goo pile that needs to be shaped and hardened in order to be useful to a business, chances are that you should make them an employee so that you can hold their hand and keep them out of trouble. 

The reason why the regulators care is that the difference defines which party gets to pay the employment taxes and do fun things like withhold and pay state and federal estimated tax payments.  Also, hiring an employee can trigger state requirements for unemployment insurance and worker's compensation. 

Other than helping the people that help you swim, the reason why your business should care is because the regulators may decide that your "contractors" are actually employees several years after the fact and subsequently stick your business with a big bill after you have racked up several years of penalties.  

So, if you are interested in the rules that can cause or prevent this from happening, here are the tests from the IRS and the similar regulations from Massachusetts (one of the toughest regulators of this law in the US).

The 20 factors that the Federal Government uses 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.

Massachusetts looks at it like this and adds a heavy handed test that requires the business to prove that the contractors are "free from control and direction":

Service performed by an individual, except in such cases as the context of this chapter otherwise requires, shall be deemed to be employment subject to this chapter irrespective of whether the common-law relationship of master and servant exists, unless and until it is shown to the satisfaction of the commissioner that—

(a) such individual has been and will continue to be free from control and direction in connection with the performance of such services, both under his contract for the performance of service and in fact; and

(b) such service is performed either outside the usual course of the business for which the service is performed or is performed outside of all the places of business of the enterprise for which the service is performed; and

(c) such individual is customarily engaged in an independently established trade, occupation, profession or business of the same nature as that involved in the service performed.

Here is a link to a case that shows how strict MA is.  LINK  Even in the case of highly qualified tutors who were hired through another company, MA claimed that they were not free from control (a) because the tutors could not hire assistants.  

Circular 230 Disclosure: To comply with Treasury Department regulations, we inform you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. tax-related penalties or promoting, marketing or recommending to another party any tax-related matters addressed herein.

Lyle PhippsComment