There are a few fundamental issues in tax law that seem to never go away. As tax attorneys, we’ll be dealing with these issues for our careers. One of those fundamental issues is whether a worker should be classified as an employee or independent contractor. In fact, because many parts of Obamacare rely on the classification of a worker as an employee, the question is actually becoming more important.
This question arises in other areas of law as well, including labor disputes. For example, this question was highlighted in a recent decision issued by the California Labor Commissioner, who ruled that a driver for Uber was actually an employee, rather than an independent contractor. Moreover, within the past few weeks, FedEx agreed to pay a $228 million settlement to resolve a case which claimed that FedEx improperly short-changed its drivers on benefits and pay by classifying those drivers as independent contractors.
Surprisingly for many people who are not tax professionals, there are no hard and fast rules that can be used to classify workers. Rather, the IRS has issued a revenue ruling which lays out 20 factors that it will use to make the classification. Other courts have their own set of factors. The Nebraska Supreme Court, for example, uses a 10 factor test.
As you can imagine, certain fundamental questions are at the heart of each of these tests. The IRS itself has classified the relevant factors into 3 main categories: Behavioral Control, Financial Control and Relationship of the Parties.
This category concerns whether the business has a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work.
Instructions. For example, if the worker receives extensive instructions on how work is to be done, that tends to establish that the worker is an employee. These instructions can cover a wide range of topics including: a) how, when, or where to do the work; b) what tools or equipment to use; c) what assistants to hire to help with the work; and, d) where to purchase supplies and services. On the flip side, if a worker simply receives instructions about what should be done or the time and place for the work to be done, and not how it should be done, that tends to establish that the worker may be an independent contractor.
Training. If a business provides the worker with training about required procedures and methods, that indicates that the business wants the work done in a certain way and tends to establish that the worker may be an employee.
This category concerns whether the business has a right to direct or control the business part of the work.
Significant Investment. If a worker has a significant monetary investment in his or her work, that tends to establish that the worker may be an independent contractor. While there is no precise dollar test, the investment must have substance.
Expenses. If a worker is not reimbursed for some or all business expenses, that tends to establish that the worker may be an independent contractor, especially if the worker’s unreimbursed business expenses are high.
Opportunity for Profit or Loss. If the worker can realize a profit or incur a loss, that tends to establish that the worker is in business for himself or herself and may be an independent contractor.
Relationship of the Parties
This category concerns how the business and the worker perceives their relationship.
Employee Benefits. If a worker receives benefits, such as insurance, pension, or paid leave, that tends to establish that the worker may be an employee.
Written Contracts. A written contract may show what both the worker and the business intend. This may be very significant if it is difficult to classify the worker based on other facts.
When Should We Get Assistance
The time to see an attorney regarding the classification of workers is not just after you, or your clients, have received notice of an audit or worker classification challenge. Rather, a little planning regarding the model under which your business uses workers could go a long way toward avoiding problems or being successful if a worker classification audit ever arose. Please contact a member of the McGrath North Tax Team if you would like to discuss these questions further.