Determining if a Worker is an Employee or Independent Contractor

Whether you’ve just launched a dynamic startup, or you’re at the helm of an established business, ensuring that you correctly classify workers on your roster is a critically important task. Unfortunately, it can also be one of the most confusing and challenging.

Indeed, the line between employee and independent contractor is a lot blurrier these days as remote workers plug in from their home office – or favorite Starbucks – and do everything from provide legal advice, deliver training, resolve customer inquiries, and handle an array of administrative tasks.

Forget about the old adage that behind every successful professional is a supportive spouse.

These days, behind every (or at least many) top performers is a hard working, highly cost-effective outsourced virtual admin!

What’s more, the distinction between employee and contractor is by no means superficial, secondary or primarily for statistical purposes. The classification directly determines mandatory worker-related costs and legal obligations.

Generally, the IRS advises businesses to assess the degree of control and independence it exerts in the relationship with each worker across three areas: behavioral control, financial control and type of relationship.

Behavioral Control

Behavioral control focuses on how much authority you have to direct and control a worker with respect to: the type of instructions given, the degree of instructions, evaluation and performance management systems, and training.

Keep in mind that behavioral control is not limited to directing or controlling how work is actually done. For example, you may not necessarily tell a worker how to carry out his or her tasks. As long as you retain the right to direct and control the work – even if you opt not to exercise that right – then there’s a strong likelihood that the IRS will conclude that, at least when it comes to behavioral control, a worker is an employee rather than an independent contractor.

Financial Control

Financial control refers to how much authority you have over how a worker is paid, whether expenses are reimbursed, whether they or you provide tools or supplies, and so on. It also covers other economic aspects, such as whether the worker has an opportunity for profit or less, and if a worker can realistically offer their services or labors in the marketplace to other clients or customers.

As you can imagine, the more financial control you have over a worker – again, whether or not you exercise this control — the more likely that the IRS will classify the relationship as employer-employee.

Type of Relationship

The type of relationship pertains to how both you and a worker perceive and view the relationship. Sources of information that ultimately help determine this are written contracts, employee benefits, the permanency of the relationship, and whether the work performed is a fundamental business aspect or activity.

For example, a restaurant may hire a chef ostensibly as an independent contractor, yet present the chef’s work as their own (i.e. the meal is provided by the restaurant), as well as control and direct the work performed (per the behavioral control section). In this case, it’s almost certain that the IRS would see this as an employer-employee relationship.

A Final Word of Warning

This example with the chef also illustrates an extremely important factor that many businesses get wrong, and end up paying big time for their mistake: it often doesn’t matter what a contract says. What the IRS looks for is how workers are viewed, treated and paid. It doesn’t even matter what a worker prefers, or if an erroneous classification was helpful to them instead of harmful.

The smartest and safest thing you can do is speak with a qualified tax attorney to make sure that if the IRS comes calling – or you face a complaint or lawsuit from a current or former worker – that you’re standing on solid ground.