J. Klutch

Monday, 22 July 2002 09:55

Employee or independent contractor?

If you’re a business owner, the question of whether to call the people who work for you employees or independent contractors has important ramifications on payroll deductions such as Social Security, workers’ compensation premiums and unemployment compensation contributions. And new IRS guidelines for making such determinations could affect the way you classify your workers.

What the courts say

Traditionally, the courts have determined that a worker constitutes an employee if the means and details, as well as the results of the work, are controlled and directed by the person for whom the work is performed. The IRS guidelines outline three categories for establishing employee status — (a) behavioral control, (b) financial control and (c) perceived relationship between the parties.

Behavioral control

The IRS breaks behavior control into instructions, training and evaluation systems. Employers have the right to control and direct how work is performed and actually exercise the right. Independent contractors, on the other hand, generally receive less extensive instructions, especially on how to actually perform the work.

Periodic or ongoing training on how to accomplish particular tasks also indicates employee status to the IRS, since such training suggests an employer wants work done in a particular way. Voluntary and uncompensated participation in training sessions, or brief orientation sessions on company policies, new product lines and new government regulations may indicate either employee or independent contractor status.

IRS guidelines suggest that regular performance evaluations to reward, promote, discipline, train, instruct or terminate workers indicate employee status.

Financial control

If a worker makes a significant investment in tools or other equipment to perform required services, he or she more likely is an independent contractor.

The guidelines also suggest that workers who are directly reimbursed for all or almost all work-related expenses are employees and not independent contractors. Salary or hourly wages generally indicate employee status, while flat fees generally indicate independent contractor status. Commissions can point to either employee or independent contractor status, the key consideration being the chance for profit or loss. A commissioned worker who pays his or her own business operating expenses has a real risk of loss, and therefore is more likely considered an independent contractor.

Unlike employees, independent contractors generally advertise, maintain a business location and work with a number of clients.

Perceived relationships

The payment of benefits such as paid vacation and sick days, health, life or disability insurance, or pension plans are all indicative of employee status.

Although written contracts which specifically identify a worker, an employee or an independent contractor may be persuasive, the IRS says that a contractual designation alone is never solely a determination of status.

Long-term relationships may indicate employee status because the worker may have little need to maintain a business presence and has little likelihood of incurring the profits or losses associated with independent contractor status.

An employer’s ability to discharge a worker at will indicates the right to control how work is performed and, therefore, suggests an employer/employee relationship. However, legal limitations on the ability to terminate employees have increased in recent years, and consequently, this factor is not as important an indicator of workers’ status as it once was.

Finally, the guidelines note that workers’ services that are part of an employer’s regular business activity suggests employee status since the company is likely to want to control how the services are performed.

While the guidelines help clarify how to classify the people who do work for your business, it’s up to you to make the necessary and appropriate legal and tax arrangements.

If you are unsure which categories your “employees” fall into, don’t wait until you’re audited to figure it out.

J. Micheal Klutch is a member of Sable Makoroff & Gusky’s Litigation Practice Group. He specializes in employment law, including employment discrimination litigation, and handles traditional labor matters such as collective bargaining, unfair labor practices and strikes. Reach him at the firm at (412) 471-4996.