Independent Contractor versus Employee

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Independent Contractor or Employee
(Revenue Ruling 87-41)


The 20 factors indicating whether an individual is an employee or an independent contractor are:

1) Instructions. An employee must comply with instructions about when, where, and how to work. Even if no instructions are given, the control factor is present if the employer has the right to control how the work results are achieved.

2) Training. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods and receive no training from the purchasers of their services.

3) Integration. An employee's services are usually integrated into the business operations because the services are important to the success or continuation of the business. This shows that the employee is subject to direction and control.

4) Services rendered personally. An employee renders services personally. This shows that the employer is interested in the methods as well as the results.

5) Hiring assistants. An employee works for an employer who hires, supervises, and pays workers. An independent contractor can hire, supervise, and pay assistants under a contract that requires him or her to provide materials and labor and to be responsible only for the result.

6) Continuing relationship. An employee generally has a continuing relationship with an employer. A continuing relationship may exist even if work is performed at recurring although irregular intervals.

7) Set hours of work. An employee usually has set hours of work established by an employer. An independent contractor generally can set his or her own work hours.

8) Full-time required. An employee may be required to work or be available full-time. This indicates control by the employer. An independent contractor can work when and for whom he or she chooses.

9) Work done on premises. An employee usually works on the premises of an employer, or works on a route or at a location designated by an employer.

10) Order or sequence set. An employee may be required to perform services in the order or sequence set by an employer. This shows that the employee is subject to direction and control.

11) Reports. An employee may be required to submit reports to an employer. This shows that the employer maintains a degree of control.

12) Payments. An employee is paid by the hour, week, or month. An independent contractor is usually paid by the job or on a straight commission.

13) Expenses. An employee's business and travel expenses are generally paid by an employer. This shows that the employee is subject to regulation and control.

14) Tools and materials. An employee is normally furnished significant tools, materials, and other equipment by an employer.

15) Investment An independent contractor has a significant investment in the facilities he or she uses in performing services for someone else.

16) Profit or loss. An independent contractor can make a profit or suffer a loss.

17) Works for more than one person or firm. An independent contractor is generally free to provide his or her services to two or more unrelated persons or firms at the same time.

18) Offers services to general public. An independent contractor makes his or her services available to the general public.

19) Right to fire. An employee can be fired by an employer. An independent contractor cannot be fired so long as he or she produces a result that meets the specifications of the contract.

20) Right to quit. An employee can quit his or her job at any time without incurring liability. An independent contractor usually agrees to complete a specific job and is responsible for its satisfactory completion, or is legally obligated to make good for failure to complete it.

Independent Contractor (Section 530 Relief)

To receive relief, a business must meet all three requirements.

I. Reasonable Basis

a. Reliance on a court case about Federal taxes or a ruling issued to you by the IRS; or

b. The business was audited by the IRS at a time when the business treated similar workers as independent contractors and the IRS did not reclassify those workers as employees; or

c. The business treated workers as independent contractors because it knew that was how a significant segment of its industry treated similar workers; or

d. The business relied on some other reasonable basis. For example, the business relied on the advice of a business lawyer or account who knew the facts about the business.

II. Substantive Consistency - the business (and any predecessor business) must have treated workers, and any similar workers, as independent contractors. If the business treated similar workers as employees, this relief provision is not available.

III. Reporting Consistency - the business must have filed Form 1099-MISC for each worker, unless the worker earned less than $600. Relief is not available for any year the business did not file the required Forms 1099-MISC. If the business filed the required Forms 1099-MISC for some workers, but not for others, relief is not available for the workers for whom the business did not file Forms 1099-MISC.

Independent Contractor (Summary of Oct 1996 IRS MSSP)

I. Critical Factors:

1. Continuing relationship - if the worker is hired for an indefinite period, the worker is considered an employee. If the worker is working on a project with a finite duration, the worker may be either an employee or independent contractor.

2. Training - if training is provided by the company at company expense, it can be assumed that the worker is an employee.

3. Guild or union benefits - it a company is making contributions to a guild or union benefit plan on behalf of a worker who is not providing services through a loan-out corporation, the worker must be considered an employee.

II. Significant Factors:

1. Establishment of business presence

a. Does the worker have an office away from home or a qualified home office?

b. Does the worker have an agent who markets the services of the worker to the public?

c. Does the worker maintain books and records of business activities separate from personal records?

d. Does the worker use preprinted invoices, stationary, business cards with a business name or logo?

e. Does the worker have a business phone line separate from a personal number?

f. Does the worker advertise in publications, have listings in trade directories, or otherwise put his/her name in the public eye as being available for work?

g. Does the worker have a federal tax EIN?

h. Is there other evidence of the worker having established a business presence?

2. Risk of Loss - a worker who has a risk of loss in his/her business activities may be an independent contractor.

a. Does the worker have a significant investment in the tools and equipment necessary for the worker's activities on the project?

b. Does the worker incur significant business expenses in the performance of the worker's job?

c. What is the method of payment? If the worker is paid a fixed fee for the services out of which unreimbursed business expenses are paid, there is strong evidence of the worker having a risk of loss.

3. Control over worker activities - if the company has the right to exercise control over the worker, it is generally an indication that the worker may be an employee.

a. If the worker may determine when and in what sequence the worker's job may be accomplished, it is consistent with the worker being an independent contractor.

b. If the worker is free to choose the location of his/her work, it is consistent with the worker being an independent contractor.

c. When the company requires the worker to maintain specific records, it is indicative that the worker is an employee.

4. Instructions at the job site - the extent of instructions is frequently not an important factor.

III. Factors not generally applicable -

1. Working for more than one employer

2. Working full time does not necessarily indicate worker status.

3. Reports (oral or written) do not determine worker status.

4. Right to discharge

5. Right to terminate

6. Integration

7. Personal services - a requirement that services be provided personally