Independent Contractor or Employee 20 Factor Test and Criteria Business Owners Need to Know
Is the person or people working for you a subcontractor or employee?
- The IRS uses a 20-point criteria test to determine a worker’s status
- Each state has its own test that generally follows the IRS test, albeit often varies greatly due to statutes
- The two primary questions asked is the older standard of “How much does the principal exert control over the worker’s means of executing the task,” as well as the newer standard of “Entrepreneur Opportunity” for the worker.
- It is possible that the Principal could be faced with a split, whereas the federal government treats the status as one and the state treats the relationship as another.
- Along with the state and IRS, employers and employees also have to contend with the National Labor Relations Board (NLRB), which often appears to be politically motivated, or at least to a greater extent than the IRS.
It’s a question asked often by business people and it’s easy to get it wrong, especially by new business owners trying to save money and the logistical burden having employees create.
As a rule, in the states that we operate, staff members are employees unless proven otherwise. The IRS has its own set of rules if an employee is a 1099 independent contractor or a W2 employee, and the various states have their own rules. So it’s not enough to satisfy only one, because if only one or the other says any given person is an employee, that’s what they are.
It’s easy to understand why sometimes everyone involved would rather a situation calls for an independent contractor instead of an employee. Employers have to pay into unemployment compensation, buy a worker’s comprehensive insurance policy and be subjected to sometimes time consuming audits, pay the employer’s side of FICA (social security), and it can change how the owner’s retirement funding is handled. For employees, expenses related to the job are deductible for federal and state income taxes, but they still have to pay the full amount to FICA.
Considering FICA is one of the worst investments you’ll likely make, it’s no surprise why so many avoid paying into it as much as possible. There’s one exception though. If you’re unhealthy from childhood, it’s a safety net that might not otherwise be there.
You may already know the above and just want to know what are some of the criteria employers and employees should know when deciding if someone is an independent contractor and should receive a 1099 at the end of the year or an employee and receive a W2.
The IRS pegs people into four key categories. An independent contractor, common-law employee, statutory employee, and statutory non-employee. The IRS has a lot of information on its website and includes:
Common Law Rules
- Behavior - Does the company control or have the right to control what the worker does and how the worker does his or her job
Some of the criteria used to determine if behavioral control is used includes the following:
Instructions the business gives the worker. An employee is generally subject to the business’ instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work:
Directing the worker what time to start and finish, and where to do the work
What tools or equipment to use, and typically using the employer’s tools
What workers to hire or to assist with the work
Where to purchase supplies and services, and usually paying for them.
What work must be performed by a specified individual, and not allowing the worker to direct another non-employee to do the work.
What order or sequence to follow, and method.
Training the business gives the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.
- Financial - Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc..). A big key is can the worker lose money. If the worker can’t lose money on the job, that tends to weigh heavily towards the employee status. Employees rarely can lose money, while business owners (i.e. independent contractors can easily lose money).
The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services they perform for their business.
The extent of the worker’s investment. An employee usually has no investment in the work other than his or her own time. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.
The extent to which the worker makes services available to the relevant market. 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.
How the business pays the worker. 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.
The extent to which the worker can realize a profit or loss. Since an employer usually provides employees a workplace, tools, materials, equipment, and supplies needed for the work, and generally pays the costs of doing business, employees do not have an opportunity to make a profit or loss. An independent contractor can make a profit or loss.
- Type of Relationship — Are there written contractos and or employee type benefits (i.e. retirement plan, insurance, vacation pay, etc)? Will the relationship continue and is the work performed a key component of the business’ needs?
Written contracts describing the relationship the parties intended to create. This is probably the least important of the criteria, since what really matters is the nature of the underlying work relationship, not what the parties choose to call it. However, in close cases, the written contract can make a difference.
Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. The power to grant benefits carries with it the power to take them away, which is a power generally exercised by employers over employees. A true independent contractor will finance his or her own benefits out of the overall profits of the enterprise.
The permanency of the relationship. If the company engages 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.
The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of the company’s regular business activity, it is more likely that the company will have the right to direct and control his or her 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.
Remember, workers are considered to be employees unless it’s shown that independent contractor is clearly the appropriate classification
Here are other factors used to test if a worker is an independent contractor or employee:
| Under the common law test, a worker is an employee if the purchaser of that worker’s service has the right to direct or control the worker, both as to the final results and as to the details of when, where, and how the work is done. Control need not actually be exercised; rather, if the service recipient has the right to control, employment may be shown. | Depending upon the type of business and the services performed, not all of the twenty common law factors may apply. In addition, the weight assigned to a specific factor may vary depending upon the facts of the case. If an employment relationship exists, it does not matter that the employee is called something different, such as: agent, contract labor, subcontractor, or independent contractor. |
| 1. INSTRUCTIONS: | 11. ORAL OR WRITTEN REPORTS: |
| An Employee receives instructions about when, where and how the work is to be performed. An Independent Contractor does the job his or her own way with few, if any, instructions as to the details or methods of the work. | An Employee may be required to submit regular oral or written reports about the work in progress. An Independent Contractor is usually not required to submit regular oral or written reports about the work in progress. |
| 2. TRAINING: | 12.PAYMENT BY THE HOUR, WEEK, OR MONTH: |
| Employees are often trained by a more experienced employee or are required to attend meetings or take training courses. An Independent Contractor uses his or her own methods and thus need not receive training from the purchaser of those services. | An Employee is typically paid by the employer in regular amounts at stated intervals, such as by the hour or week. An Independent Contractor is normally paid by the job, either a negotiated flat rate or upon submission of a bid. |
| 3. INTEGRATION: | 13. PAYMENT OF BUSINESS & TRAVEL EXPENSE: |
| Services of an Employee are usually merged into the firm’s overall operation; the firm’s success depends on those Employee services. An Independent Contractor’s services are usually separate from the client’s business and are not integrated or merged into it. | An Employee’s business and travel expenses are either paid directly or reimbursed by the employer. Independent Contractors normally pay all of their own business and travel expenses without reimbursement. |
| 4. SERVICES RENDERED PERSONALLY: | 14. FURNISHING TOOLS & EQUIPMENT: |
| An Employee’s services must be rendered personally; Employees do not hire their own substitutes or delegate work to them. A true Independent Contractor is able to assign another to do the job in his or her place and need not perform services personally. | Employees are furnished all necessary tools, materials, and equipment by their employer. An Independent Contractor ordinarily provides all of the tools and equipment necessary to complete the job. |
| 5. HIRING, SUPERVISING & PAYING HELPERS: | 15. SIGNIFICANT INVESTMENT: |
| An Employee may act as a foreman for the employer but, if so, helpers are paid with the employer’s funds. Independent Contractors select, hire, pay, and supervise any helpers used and are responsible for the results of the helpers’ labor. | An Employee generally has little or no investment in the business. Instead, an Employee is economically dependent on the employer. True Independent Contractors usually have a substantial financial investment in their independent business. |
| 6. CONTINUING RELATIONSHIP: | 16. REALIZE PROFIT OR LOSS: |
| An Employee often continues to work for the same employer month after month or year after year. An Independent Contractor is usually hired to do one job of limited or indefinite duration and has no expectation of continuing work. | An Employee does not ordinarily realize a profit or loss in the business. Rather, Employees are paid for services rendered. An Independent Contractor can either realize a profit or suffer a loss depending on the management of expenses and revenues. |
| 7. SET HOURS OF WORK: | 17. WORKING FOR MORE THAN ONE FIRM AT A TIME: |
| An Employee may work “on call” or during hours and days as set by the employer. A true Independent Contractor is the master of his or her own time and works the days and hours he or she chooses. | An Employee ordinarily works for one employer at a time and may be prohibited from joining a competitor. An Independent Contractor often works for more than one client or firm at the same time and is not subject to a non-competition rule. |
| 8. FULL TIME REQUIRED: | 18. MAKING SERVICE AVAILABLE TO THE PUBLIC: |
| An Employee ordinarily devotes full-time service to the employer, or the employer may have a priority on the Employee’s time. A true Independent Contractor cannot be required to devote full-time service to one firm exclusively. | An Employee does not make his or her services available to the public except through the employer’s company. An Independent Contractor may advertise, carry business cards, hang out a shingle, or hold a separate business license. |
| 9. LOCATION WHERE SERVICES PERFORMED: | 19. RIGHT TO DISCHARGE WITHOUT LIABILITY: |
| Employment is indicated if the employer has the right to mandate where services are performed. Independent Contractors ordinarily work where they choose. The workplace may be away from the client’s premises. | An Employee can be discharged at any time without liability on the employer’s part. If the work meets the contract terms, an Independent Contractor cannot be fired without liability for breach of contract. |
| 10. ORDER OR SEQUENCE SET: | 20. RIGHT TO QUIT WITHOUT LIABILITY: |
| An Employee performs services in the order or sequence set by the employer. This shows control by the employer. A true Independent Contractor is concerned only with the finished product and sets his or her own order or sequence of work. | An Employee may quit work at any time without liability on the Employee’s part. An Independent Contractor is legally responsible for job completion and, on quitting, becomes liable for breach of contract. |
Entrepreneur Opportunity Test
As mentioned in the beginning, another test that is becoming increasingly prevalent in a given regulator or court’s analysis is the “entrepreneur opportunity” test. (although it’s important to note the importance of this analysis does shift from time to time as seen in the National Labor Relations Board in The Atlanta Opera, Inc. and Make-Up Artists and Hair Stylists Union, Local 798, in which the NLRB reversed its 2019 decision in SuperShuttle DFW, Inc. and used its previous criteria in the 2014 FedEx Home Delivery decision).
For example, in writing it’s decision, the NLRB highlighted the role of “entrepreneurial opportunity” in its analysis, clarifying that putting forth evidence of entrepreneurial opportunity, among other considerations, is relevant to whether a putative contractor rendered services as part of an independent business. Thus, rather than treating entrepreneurial opportunity as a “superfactor,” or as a determiner that cast aside other “lessor” considerings and facts by which to weigh the various other factors, the NLRB did consider entrepreneurial opportunity as one of the many key elements of the non-exhaustive common law test used. The NLRD additionally highlighted the difference of bonafide “actual opportunities,” permitting “the exercise of genuine entrepreneurial autonomy,” in contrast to “those that are circumscribed or effectively blocked by the employer.” Where the day-to-day work of most individuals in a bargaining unit does not have an entrepreneurial dimension, the NLRD noted that the mere fact the agreement and contract permits outside entrepreneurial activity is not a sufficient allowance and flexibility to the workers to characterize the stylists as individuals independent contractors enabled to select and choose what opportunities they wish to avail themselves to.
Furthermore, it should be noted as part of assessing the proper classification of the stylists workers, the NLRD stated a few factors that may be highly helpful for principals wishing to maintain or develop a relationship with works as independent contractors, including:
- The stylists were engaged in a distinct occupation or business,
- The skill required in the occupation, and
- The duration of the relationship.
In contrast, other informative factors weighed in favor of an employment relationship include:
- The control exercised over the day-to-day work,
- The supervision by the Principal,
- The providing by the principal of equipment, supplies and place of work,
- The method of payment, and
- The relationship of the stylists’ work to the regular business of the Principal.
As I have advised so many times to clients, an assessment of the parties’ expectations as to working relationship was inconclusive. While unintuitive and confusing to most business owners (and workers alike), and perhaps even against common sense in a supposedly free-market driven economy, the expectations and agreements between the parties is a low or often non-existent (in terms of weighing the facts and criteria) factor.
Finally, determining if the stylists workers rendered services as an independent business or as employees, the NLRB determined and found the stylists workers were “fundamentally constrained” and limited in their own independent entrepreneurial choices available, based on the the manner in which the principal directed and compelled its schedules and virtually all entrepreneurial decisions, and based on the fact that workers were paid a fixed hourly wage and had no ownership over their positions or work. While the NLRB recognized that stylists may have the opportunity to work for other entities, or for their own in other locations, and do in fact regularly pursue such opportunities when they are not working for the principal, the NLRB reached a conclusion the stated opportunity open to the stylists was primarily based on the seasonal and intermittent nature of their work for the principal, and not continuous and selective based on the stylists desires.
In conclusion, the NLRB reached a determination the stylists do not render services as part of their own, independent business separate from overriding direction of the principal. Therefore, the NLRB found the stylists to be statutory employees and not independent contractors. This of course can be an extremely costly determination for the principal and highlights the importance of not only structuring the contract appropriately, albeit to also structure the expectations and working environment in such a manner as to overcome scrutiny by government actors intervening in the relationship. Business owners are well advised to seek legal counsel so as to not fall into the trap of failing to running afoul of a government regulator.