Whether to treat an individual who
provides services in your trade or business as an employee or
independent contractor is a question often raised by business
owners. It is also of serious concern to the IRS, EDD and
other State tax agencies.
Employers, given a
choice, might prefer to pay someone as an independent contractor
as it saves them from having to pay the employer's share of
FICA, Medicare, FUTA and other taxes. Further, other
benefit programs that are for the benefit of employees may not
apply to independent contractors (non-employees), saving the
employer even more money. Worker's compensation liability
is typically based on employee earnings, and not those of
For the individual
receiving compensation, their take-home pay as an independent
contractor is the gross amount of their compensation. They
typically file a Schedule C (self-employed business schedule) on
their tax return, and report the gross receipts less any
business expenses incurred in earning those receipts. The
independent contractor is responsible for paying their social
security and Medicare taxes (called SECA) and their state
and federal income taxes. The SECA and Medicare costs are
twice what they would have paid as an employee. Further,
an independent contractor typically loses certain rights such as
access to employee benefits (health insurance, vacation
What is important to
understand is that the tax agencies will look to the actual
working relationship between the company/employer and the
individual performing services and getting paid for those
services. Regardless of any agreement between the parties
(such as an independent contractor agreement), if the actual
relationship is employer-employee, then the employer can be
required to pay all of the taxes that should have been withheld
from the employee, plus the employer taxes, and likely some
penalties as well.
whenever someone is "hired" to provide services to a company,
the nature of those services must be evaluated in connection
with the "20 common-law factors" that the IRS uses to determine
if an employer-employee relationship exists. If the
company makes the decision to pay the individual as an
independent contractor, the company may wish to consult an
attorney. The purpose for this will be to draw up an
agreement to enable the employer to easily recover from the
"employee" the employee's share of income tax, FICA and other
amounts that should have been withheld - if a tax agency makes a
determination that an employer-employee relationship exists.
The bottom line is that under common law, a worker is an
employee if the person for whom they work has the right to
direct and control the way they work, both as to the final
result and as to the details of when, where, and how the work is
to be done. It is the IRS view that the employer need not
actually exercise control. It is sufficient that
they have the right to do so.
are the 20 factors the IRS (and EDD) consider:
1. Is the person
providing services required to comply with instructions about
when, where, and how the work is to be done?
2. Is the person
provided training to enable them to perform a job in a
particular method or manner?
3. Are the
services provided integrated into the business' operation?
4. Must the
services be rendered personally?
5. Does the
business hire, supervise or pay assistants to help the person
performing the services under contract?
6. Is the
relationship between the individual and the person they
perform services for a continuing relationship?
7. Who sets the
hours of work?
8. Is the worker
required to devote their full time to the person they perform
9. Is the work
performed at the place of the business of the potential
10. Who directs
the order or sequence in which the work must be done?
11. Are regular
written or oral reports required?
12. What is the
method of payment - hourly, commission or by the job?
13. Are business
and/or traveling expenses reimbursed?
14. Who furnishes
tools and materials used in providing services?
15. Does the
person providing services have a significant investment in
facilities used to perform services?
16. Can the person
performing the services realize both a profit or a loss?
17. Can the person
providing services work for a number of firms at the same
18. Does the
person make their services available to the general public?
19. Is the person
providing services subject to dismissal for reasons other than
nonperformance of contract specifications?
20. Can the person
providing services terminate their relationship without
incurring a liability for failure to complete a job?
If you are unclear
about how to classify an individual, seek professional guidance
before agreeing to pay that person as in independent contractor.
There was a recent
Appellate Court case that deal with a satellite TV installer and
status as an employee vs. independent contractor. While
this was a labor case (dealing with overtime pay), what is
important is the analysis that the Court did in reaching its
conclusion that the installer was an independent contractor.
Satellite TV installer was independent contractor not entitled
to overtime pay
Hi-Tech Satellite, Inc.,
CA11, Dkt. No. 05-14091, 5/31/2006
The Eleventh Circuit Court of
Appeals has upheld a district court ruling that a satellite
system installer was an independent contractor, rather than an
employee, and therefore he was not entitled to overtime pay even
though he worked six days each week for one particular company.
The specific details about how the
installer carried out his duties for the satellite company were
left to him with the exception that: (1) he was not allowed to
perform any additional services that were not paid for by the
customers without the satellite company's approval; (2) he had
to wear the satellite company's shirt during appointments; (3)
he had to follow certain minimum specifications for the
installations; and (4) he had to call the satellite company to
confirm that he had completed the installation and to report any
problems that had arisen. The installer was free to perform
installations for other companies. Several other installers for
the satellite company had created their own corporate entities.
Whether an individual is an
employee or independent contractor for purposes of the Fair
Labor Standards Act (FLSA) is determined on a case-by-case
basis. The U.S. Supreme Court has ruled that certain factors
must be taken into account. Those factors are discussed below.
and degree of the alleged employer's control as to the manner in
which the work is to be performed.
The district court determined that
the satellite company exerted very little control over the
installer. Although the satellite company would schedule
installation appointments for the installer, the installer could
change them. The details of how the installer carried out his
duties were generally left to him.
employee's opportunity for profit or loss depending upon his
managerial skill. The
district court noted that the installer was compensated mainly
by the job and not by the hour. Therefore, by accepting more
jobs, performing more efficiently, and hiring employees, the
installer could earn greater sums of money.
employee's investment in equipment or materials required for his
task, or his employment of workers.
The installer drove his own vehicle
and provided his own tools and supplies for each installation.
service rendered requires a special skill.
From the record evidence and
testimony, the district court discerned that the installer
needed special skills to properly install home satellite and
The degree of
permanency and duration of the working relationship.
The district court concluded that
the installer's relationship with the satellite company was not
one with a significant degree of permanence. It based its
conclusion on the fact that the installer was able to take jobs
from other installation brokers. The installer could take as
many or as few jobs as he desired.
The extent to
which the service rendered is an integral part of the alleged
employer's business. In
the only factor weighing in the favor of the installer being
classified as an employee, the district court found that the
installer's services were an integral part of the satellite
The Court of Appeals upheld the
district court's ruling that the installer was an independent
contractor based on the above analysis. The Court of Appeals
said that there was no evidence that the satellite company's
relationship with the installer was any different from its
relationship with its other 785 installers, and those installers
were treated as independent contractors. The court acknowledged
that the installer worked six days a week for the satellite
company, but noted that the installer was not required to do so,
especially in light of the evidence that some of the other
installers worked for the satellite company's competition at the
same time as they worked for the satellite company.
* * * * * * * * * *
Here is a discussion
of a 2007 case in which the determination of an individual's
status as that of an independent contractor or an employee was
discussed at length:
Worker liable for self-employment tax because he wasn't an
Commissioner, TC Memo
2007-249, Dkt. No. 18719-05, 8/27/2007
The U.S. Tax Court
has ruled that a company was correct in not withholding FICA tax
from a worker who was an independent contractor.
Uriah Jones, a marble and tile
installer, worked on a condominium renovation for DBMA
Corporation (DBMA) for four months in 2003. DBMA paid Jones
$8,360 for his work. At no point did Jones ever sign or submit a
Form W-4. In 2003, Jones worked for three other companies that
treated him as an employee, and all three companies issued him
Forms W-2, rather than Forms 1099-MISC (used for independent
contractors). Jones didn't report the income he received from
DBMA on his federal personal income tax return.
Independent contractors pay
self-employment tax (SECA) [see IRC §1401 et seq.]. Employees
are subject to FICA tax. The overall tax rate is the same, but
whereas employers split the FICA tax liability with employees,
independent contractors pay the entire SECA. Jones believed he
was an employee of DBMA. An employee for purposes of IRC
§3121(d) includes a common law employee.
looked at the following factors to determine whether Jones was a
common law employee: (1) degree of control; (2) investment in
facilities; (3) opportunity for profit or loss; (4) the right of
the principal to discharge the individual; (5) whether the work
performed was an integral part of the principal's regular
business; (6) the permanency of the relationship; and (7) the
relationship the parties believed they were creating.
The court reviewed the factors
above and held that Jones was an independent contractor.
With respect to (1) above, the
court said that Jones' degree of control over his own work on
the condominium renovation was consistent with independent
contractor status. The court noted that Jones was free to
complete the work he was contracted to do by the means and
methods of his choice.
to (2) above, the court noted that Jones provided his own tools
and most supplies. Additionally, he was not reimbursed by DBMA
for the materials that he provided. These facts supported
independent contractor status.
to (3) above, the court noted that DBMA paid Jones a fixed sum
regardless of the time spent on the job. If Jones underestimated
the cost of the supplies needed, or the time it took to complete
the job, he bore the risk of losing money, not DBMA.
Furthermore, if assistants were needed, it was Jones' sole
responsibility to hire and pay them. Additionally, Jones bore
the risk of loss on any loss or damage to his work tools. These
facts supported independent contractor status.
to the right to discharge, the court said that the fact that
Jones could not be discharged as long as his work met DBMA's
specifications was consistent with independent contractor
to (5) above, the court noted that the condominium renovation
required tile work, and therefore Jones' job was an integral
part of DBMA's work. The court believed that the integral nature
of Jones' work could support employee status.
to (6) above, the court noted that once DBMA completed the
condominium renovation, the relationship between Jones and DBMA
ended. This factor supported independent contractor status.
to (7) above, there was a discrepancy between the parties
regarding the relationship they believed that they were
creating. Jones thought that an employment relationship was
being created as he had always has been treated as an employee
by other marble and tile companies. DBMA always treated its
workers as independent contractors. The court said that the
facts supported independent contractor status as Jones had
failed to submit a Form W-4 to DBMA. (He had submitted a Form
W-4 to his three other employers.) In addition, there was no
indication that Jones had requested or inquired about a Form W-4
noted that only one of the above factors supported employee
Lastly, anytime you
have an employee working for you, all wages you pay that
employee, including bonuses, awards, etc, should be reported on
form W-2 and proper taxes withheld. An individual
does NOT have a dual-status with their employer. An
exception can be for an employee (usually a corporate office)
who is a member of a Board of Directors for a Corporation.
An individual in that capacity is typically considered to be
performing services as a director in a self-employed capacity.
Salesman wasn't statutory
employee; deductions were subject to 2% of AGI floor
The Tax Court has
held that a salesman didn't qualify as a statutory employee
Code Sec. 3121(d)(3)
and as a result, couldn't claim business
deductions on Schedule C. Rather, he was a common law employee
whose out-of-pocket employment related expenses were only
deductible on Schedule A, subject to the 2% of adjusted gross
income (AGI) floor. The fact that an audit of an earlier tax
year permitted him to file as a statutory employee didn't
adjusted gross income (AGI), income derived from rendering
services as a statutory employee described in
Code Sec. 3121(d)(3)
is income from a trade or
business—reportable on Schedule C (Form 1040)—and all allowable
deductions attributable to the earning of that income may be
taken as a trade or business expense. (
Rev Rul 90-93, 1990-2 CB 33 )
By contrast, a common law employee's earnings are reported as
wages and his out-of-pocket business-related deductions are
deducted on Schedule A to the extent they exceed 2% of his AGI.
Under the common law
rules (so-called because they originate from court cases rather
than from the Code), an individual generally is an employee if
the enterprise he works for has the right to control and direct
him regarding the job he is to do and how he is to do it. In
general, the factors used to determine if an individual is a
common law employee are:
degree of control exercised by the principal;
party invests in work facilities used by the individual;
opportunity of the individual for profit or loss;
the principal can discharge the individual;
the work is part of the principal's regular business;
permanency of the relationship;
relationship the parties believed they were creating;
provision of employee benefits.
An individual is a
statutory employee under
Code Sec. 3121(d)(3)
only if he is not a common law employee
Code Sec. 3121(d)(2)
, or an officer of a corporation under
Code Sec. 3121(d)(1)
Code Sec. 3121(d)(3)(D)
, one of the statutory employee categories
consists of a traveling or city salesman, other than as an
agent-driver or commission-driver, engaged on a full-time basis
in the solicitation on behalf of, and the transmission to, his
principal (except for sideline sales activities on behalf of
some other person) of orders from wholesalers, retailers,
contractors, or operators of hotels, restaurants, or other
similar establishments for merchandise for resale or supplies
for use in their business operations. The contract of service
must provide that substantially all of such services are to be
performed personally by the individual. An individual isn't a
traveling or city salesman if he has a substantial investment in
facilities used in connection with the performance of such
services (other than in facilities for transportation), or if
the services are in the nature of a single transaction not part
of a continuing relationship with the person for whom the
services are performed.
Rosemann was an outside salesman for Cooper Container Corp. and
received a salary and quarterly commissions for taking orders
for cardboard containers and packaging. He worked mainly out of
his vehicle and his home. Rosemann was required by Cooper to
work 40 hours per week during business hours and to report to
its place of business for meetings once or twice a week. He
could not wear casual clothes in Cooper's offices or when
calling on customers. Cooper had the right to discharge Rosemann
at will and provided him with a $5,000 life insurance policy, 3
weeks of annual paid vacation leave, sick leave, health
insurance, a 401(k) retirement plan, and an auto to use for
business (as well as some personal) purposes. The Forms W-2,
Wage and Tax Statement, which Rosemann received from Cooper did
not indicate in box 13 that Rosemann was a statutory employee.
Cooper withheld Federal taxes as well as Social Security and
Medicare taxes from Rosemann's wages and commissions.
When IRS audited
Rosemann's '95 and '96 returns, the auditor agreed that he was
then qualified as a statutory employee, and Rosemann continued
using that same status in his income tax returns for later
years. On his 2004 and 2005 returns, Rosemann claimed Schedule C
deductions of $4,745 and $6,438 respectively. IRS audited those
years and determined he was a common law employee rather than a
statutory employee, and that his work-related deductions were
improperly claimed on Schedule C and should have been claimed on
Schedule A as employee business expenses, subject to the
Taxpayer wasn't a
statutory employee. The Tax Court concluded that he was a
common law employee under the eight-part test explained above
and thus was automatically barred from being a statutory
employee. It found that:
Rosemann had some independence and flexibility in
planning his sales work and contacting customers in
promoting company products, Cooper retained and
exercised considerable control over his activities. He
was an at-will employee, as were all who worked for
Cooper. He was subject to dismissal, had to attend
regular weekly meetings at the Cooper facility, had to
keep normal business hours (a minimum of 40 hours per
week), and had to observe Cooper's no-jeans dress code.
His productivity was periodically checked and Cooper's
officers treated him as an employee.
Rosemann's work for Cooper did not involve a risk of
financial loss. Cooper invested in facilities (including
his business car), not him.
was paid a salary and commissions, with periodic
reconciliations and didn't otherwise have any
opportunity for profit or loss while he worked for
retained the right to discharge Rosemann at will.
Rosemann's selling services were an integral part of
Cooper's regular business of manufacturing and selling
cardboard shipping containers and packaging.
worked for Cooper since '92, indicating a significant
permanency of the relationship between the two.
Rosemann and Cooper had no written employment contract,
Cooper retained the right to discharge Rosemann and
other controls over his employment, elected not to check
the box 13 on Forms W-2 indicating that Rosemann was a
statutory employee, withheld income taxes, employment
taxes, and Medicare taxes, and provided him with several
employee benefits.This tended to show that the nature of
the relationship Cooper thought it was creating with
Rosemann was that of employer-employee.
received substantial benefits from his employer (e.g.,
vacation, health insurance, life insurance, sick leave,
The Tax Court
acknowledged that Rosemann passed muster as a statutory employee
when he was audited in the '90s, but pointed out that each tax
year stands alone, with IRS retaining the right to challenge in
a succeeding year what was condoned or agreed to in a previous