Employers must make a determination whether someone who works for them is an employee or an independent contractor.
To assist them with this, the IRS has issued the “Twenty Factor Test”. Here are the tests an employer applies in order to help make this determination:
|1. Instructions||11. Oral or written reports|
|2. Training||12. Payment by the hour, week , or month|
|3. Integration||13. Payment of business and/or travel expenses|
|4. Services rendered personally||14. Furnishing of tools and materials|
|5. Hiring, supervising, and paying assistants||15. Significant investment|
|6. Continuing relationship||16. Realization of profit or loss|
|7. Set hours of work||17. Working for more than one firm at a time|
|8. Full time required||18. Making service available to the general public|
|9. Doing work on employer premises||19. Right to discharge|
|10. Order or sequence set||20. Right to terminate|
None of these twenty carries more weight than the other. These tests help clarify the degree of control an employer may have to establish an employer-employee relationship. The determination as to whether someone is an employee or an independent contractor is made by the employer taking into account the occupation and the facts and circumstances.
There is a financial incentive for employers to classify employees as independent contractors. When an employer hires an employee they must pay:
- Social Security matching up to the wage base and Medicare matching
- Federal Unemployment
- State Unemployment
- Workers Compensation Insurance
- Other benefits provided by the company such as vacation time, health insurance, or a retirement plan match
If an employer classifies someone as an employee, they will need to obtain three tax documents before they begin working.
If an employer classifies someone as an independent contractor, they need to comply with the 1099 reporting rules. Additionally, it's a good idea if they obtain a certificate of insurance before they start working.
ACTION ITEM: Employers should use the IRS Twenty Factor Test as a guide when deciding how to classify workers.
Thomas F. Scanlon, CPA, CFP®