This sounds like it might be really easy to define, but this is actually a really common question. The IRS has some really great guidelines on what makes an employee an employee and a contractor a contractor. These guidelines are called the Common Law Rules:
- Behavioral - Does the company control or have the right to control what the worker does and how the worker does his or her job?
- 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.)
- 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?
Business owners must weigh all these factors when determining whether a worker is an employee or contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is a contractor. Directly from the IRS: There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.
The key is to look at the entire working relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.
The IRS defines behavioral control as the facts that show whether there is a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done—as long as the employer has the right to direct and control the work.
Defined by the IRS as facts that show whether or not the business has the right to control the economic aspects of the worker’s job. The financial control factors fall into the categories of:
- Significant investment
- Unreimbursed expenses
- Opportunity for profit or loss
- Services available to the market
- Method of payment
A contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many jobs, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment.
Additionally, a significant investment is not necessary to be considered a contractor as some types of work simply do not require large expenditures.
Independent contractors are also more likely to have unreimbursed expenses when compared to employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also have unreimbursed expenses in connection with their job!
An Independent Contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.
An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
This refers to facts that show how the worker and business perceive their relationship to each other. The factors, for the type of the relationship between two parties, generally fall into the categories of:
- Written contracts
- Employee benefits
- Permanency of the relationship
- Services provided as key activity of the business
Although a contract may state that the worker is an employee or an independent contractor, this isn’t exactly enough to determine the worker’s status. The IRS is not required to follow a contract that the worker is an independent contractor, responsible for paying his or her own self employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.
This includes things like insurance, pension plans, paid vacation, sick days, and disability insurance. Businesses generally do not grant these benefits to contractors. However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor.
If a business hires a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control the worker’s activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.
Our comments may not contain a full description of all the facts or a complete exposition and analysis of all relevant authorities. Furthermore, the use of certain words such as “should, would, or will” is merely for grammatical convenience, is not intended to indicate a specific level of authority regarding a particular issue, and no explicit or implicit references should be taken there from. Our comments expressed herein are based upon the provisions of the Internal Revenue Code and Regulations in force on the date hereof, all proposed amendments to these Acts, Regulations and treaties publicly announced by the relevant authorities. Each and all of these authorities are subject to change at any time. Any such change could be given retroactive effect with respect to the transactions described herein and could cause the conclusions provided to become invalid, in whole or in part, with respect to any entity involved. There can be no assurance that these authorities will not disagree with, or challenge, the views set forth in this memorandum or that any such challenge will be unsuccessful.