Independent Contractor or Employee?
By Ronald I. Paltrowitz, Esq.
On February 18, 2010, The New York Times published an article by Steven Greenhouse with the headline “U.S. Cracks Down on ‘Contractors’ as a Tax Dodge.” The article referred to a federal study that concluded that 3.4 million regular employees were being treated by their employers as “independent contractors” presumably so that the employer might avoid paying Social Security, Medicare, and unemployment and workers’ compensation insurance taxes, and that, on average, independent contractors under report their income by 30%. The federal government hopes to increase tax revenues by $7 billion over the next 10 years as a result of the crackdown. (New York State, along with 36 other states, will also begin more stringent enforcement procedures.) The penalties for companies that misclassify one or more of their employees as independent contractors are not insubstantial. Such a determination can result in the payment of all of the taxes that should have been paid plus penalties and interest.
In light of all this, it is now more critical than ever that a business owner correctly classify the individuals providing services to the business as either independent contractors or employees. Simply stated (although not simply applied), the determination is based upon the degree of control the employer has over the worker and the degree of independence the worker has from the employer. While the IRS does not have any hard and fast rules, it will consider all of the specific facts that provide evidence regarding these two factors, i.e. control vs. independence. The facts fall into three general categories: 1.Behavioral; 2. Financial; and, 3. the Business Relationship. The following are example of the questions that need to be asked and correctly answered in each area:
1. Does the business have the right to control what and how the worker does his or her job?
2. Does the business determine when and where the work is to be done and/or the tools or equipment to be used?
3. Does the worker have the right to hire assistants and/or purchase the necessary supplies, or is this the sole prerogative of the business?
4. Does the business have the right to determine who must perform a particular task and/or the order or sequence in which the work must be performed?
5. What degree of instruction/training is provided by the business?
6. Does the business evaluate the how the work is performed or just the end result?
7. Does the worker have a significant financial investment in the business aspects of the worker’s job and/or the equipment or tools that are used?
8. Does the worker have overhead expenses that are not reimbursed by the business?
9. Does the worker have the opportunity to make a profit or suffer a loss?
10. Does the worker have the right to perform similar services for other businesses, and may the worker advertise and market his or her services?
11. Does the worker maintain a separate business location?
12. Is the worker paid an hourly or weekly salary or a fixed fee?
III. Business Relationship
13. Do the worker and the business have a written agreement?
14. Does the worker receive any employee type benefits like vacation pay, paid sick leave or insurance?
15. Has the worker been hired for an indefinite period rather than for a specific project or period?
16. Are the services being provided a key aspect of the business that must be provided on an on going basis?
Clearly, when weighing the factors, some may indicate that a particular worker is an employee while others may weigh in favor of independent contractor status. The IRS does not set a specific number of factors that determines the worker to be one or the other. Rather, the business must consider the entire relationship and determine the extent of control. And the decision should never be made without the assistance of professionals who work in this area.
© 2010 Ronald I. Paltrowitz, Esq. Ronald I. Paltrowitz is Vice-President and General Counsel of the Manhattan Chamber of Commerce. Acting as an outsourced general counsel for his clients, Mr. Paltrowitz provides legal and business counseling to entrepreneurs and closely held enterprises in the areas of corporate and business law, real estate, intellectual property, and commercial litigation and arbitration Send your queries for this column to email@example.com. This column is for your general information only and does not substitute for legal or accounting advice regarding your specific situation.