Employee Or Independent Contractor:
Have You Classified Your Workers Correctly?

The decision to classify workers as employees or independent contractors is a decision which has crucial tax consequences.  The Internal Revenue Service and state employment tax agencies have, in recent years, undertaken substantial audit activity to determine whether employers have improperly characterized "employees" as "independent contractors" for the purpose of avoiding the payment of Social Security, Medicare and unemployment taxes, and the withholding of income, Social Security and State Disability taxes on wages that are actually or constructively paid to an employee.

Even the unintentional misclassification of a worker as an independent contractor rather than an employee will cause the imposition of substantial financial liability on the part of the employer.  In addition to being liable for the employment taxes which would have been payable if the employer had correctly classified the worker as an employee, the employer will also likely be required to pay the amount of income and other payroll taxes that should have been withheld from compensation received by the employee, in the event the employee has failed to do so.  Intentional misclassification will also result in the imposition of substantial penalties.

The amount of control you exercise over the worker is the principal determining factor as to whether you are dealing with an independent contractor or an employee.

If you incorrectly characterize your attendant as an independent contractor, paying no heed to the payroll tax requirement, and the day comes when you elect to terminate the attendant’s services, you may be faced with a claim for unemployment compensation and audits by the Employment Development Department and the Internal Revenue Service.

It is not unusual to see an owner of a dry cleaners hire a worker Monday morning at 9:00 a.m. and terminate the worker by noon for unsatisfactory performance.  Treating the worker as an independent contractor, without regard to payroll tax deductions, may seem to be momentarily expedient, but it will not seem so when the attendant files a claim for unemployment compensation that very afternoon!

Your misguided determination as to employee or independent contractor status will not be binding upon the Internal Revenue Service or your state employment tax agency.  When these taxing agencies determine that you have improperly treated a worker as an independent contractor rather than an employee, you may be confronted with audits under which your former

workers will also be classified as employees rather than independent contractors. 

Of what consequence is such a determination?  Unless you can locate these past workers and obtain declarations under which they state under penalty of perjury that they have paid their taxes, the government will require you to pay all of the amounts that you should have withheld for the past three years had you properly treated these individuals as employees.

If you conduct your dry cleaning business through a corporation, the government will reach through the so-called “corporate shield” as though it was made of cotton candy.  If the corporation is without sufficient funds to respond, the government will move to collect the taxes from any “responsible person” related to the employer.  Officers of the corporation, for example, particularly those officers with any control over funds, are generally considered “responsible persons” and subject to such tax liability, regardless of their ownership interest in the corporation.

The Internal Revenue Service has developed a 20-factor test to determine whether a worker is an employee or independent contractor.  These factors are designed to help determine whether sufficient control, the principal element, is present to establish an employer-employee relationship.  These factors are as follows:

 (1) Instructions.  A worker who must comply with another person's instructions about when, where and how the worker is to perform, is ordinarily considered an employee.  This factor of control is generally given considerable weight.

 (2) Training.  A worker required to learn by working with an experienced employee suggests that the services are to be performed in a particular method or manner and thus is further evidence of the control reflective of an employer-employee relationship.

 (3) Integration.  When the success of a business depends to an appreciable degree upon the performance of certain services, the worker who performs these services must necessarily be subject to a certain amount of control by the owner of the business.

 (4) Services rendered personally.  Services rendered personally by the worker would indicate an employer-employee relationship.

 (5) Hiring, supervising and paying assistants.  If a worker hires, supervises or pays assistants under a contract under which the worker has agreed to provide materials and labor, and under which the worker is responsible for the attainment of a result, independent contractor status may be indicated.

 (6) Continuing relationship.  This factor indicates an employer-employee relationship.

 (7) Set hours of work.  If the hours of work are set by the supervisor, the relationship is more likely employer-employee.

 (8) Full time required.  If full time work is required, an employer-employee relationship is indicated.

 (9) Doing work on employer premises.  Such activity indicates an employer-employee relationship.

(10) Order of sequence set.  If a worker must perform services in the order or sequence established by the owner of the business or supervisor for whom the services are to be performed, this factor demonstrates that the worker is not free to follow his or her own pattern of work, but must, instead, follow established routines and schedules.

(11) Oral or written reports.  A certain degree of control is demonstrated by the requirement that the worker submit regular reports to persons for whom services are to be performed.

(12) Payment by hour, week, month.  Such payment indicates an employer-employee relationship.

(13) Payment of business and/or traveling expenses. Such payment indicates an employer-employee relationship.

(14) Furnishing of tools and materials.  If the owner of the business provides the tools and materials, rather than the worker providing his or her own tools, an employer-employee relationship is indicated.

(15) Significant investment.  If a worker invests in equipment that is used by the worker in performance of the services such as the maintenance of an office rented at fair market value from an unrelated party, such a factor would indicate that the worker is an independent contractor.  If, on the other hand, there has been no investment in facilities, it would appear that the worker has dependence upon the person for whom services are to be performed and the existence of an employer-employee relationship is indicated.

(16) Realization of profit or loss.  If a worker has a bona fide liability for expenses such as salary payments to unrelated employees, the worker would appear to be an independent contractor.

(17) Working for more than one firm at a time.  If the worker devotes all of his or her attention to one firm, an employer-employee relationship is indicated.

(18) Making service available to the general public.  An independent contractor relationship would be indicated.

(19) Right to discharge.  An independent contractor can generally not be fired so long as such an individual produces a result that meets contract specifications; however, if the person for whom services is to be performed has the right to exercise control through the threat of dismissal, the worker would appear to be an employee.

(20) Right to terminate.  If a worker has the right to end the relationship without incurring liability, such a factor would indicate an employer-employee relationship.

The moral of the story?  If you treat your workers as employees, the Internal Revenue Service and your state employment tax agency will have nothing to complain about.  If you do otherwise, you may find yourself with a business headache for which there is no inexpensive over-the-counter remedy!

[This column is intended to provide general information only  and
is  not intended to provide specific legal advice; if you have  a
specific  question  regarding the  law,  you  should  contact  an
attorney  of your choice.  Suggestions for topics to be discussed
in this column are welcome.]


Reprinted from Fabricare
Myles M. Mattenson © 2007