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The IRS Independent Contractor Test

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The IRS Independent Contractor Test

  • Course: Employment Law 101
  • Module: Hiring Process
  • Lesson Type: Video
  • Lesson Duration: 7:22

Lesson Content

This segment we're going to talk about something different. We talked about worker misclassification as it pertains to an independent contractor. An employee from a common law perspective using something called the economics realities test and the economic realities test is based off of case law interpreting how people should be paid under the Fair Labor Standards Act predominantly.

Now, we're going to look at another test and sometimes the question needs to be analyzed differently depending upon whose asking the question. This next test we're going to call the IRS test because the Internal Revenue Service looks at this relationship very, very carefully. As I mentioned in other segments, if an employee is misclassified as an independent contractor then the employer is not paying a significant amount of taxes and benefits for that employer and the IRS will go after the employer seeking to recoup those benefits.

Historically, the IRS has had a twenty-part test and, in about 2004 or 5, the IRS consolidated a lot of those and created now a, a, essentially it has like thirteen segments, but there are three main questions that are asked. One is, to what extent is the business exerting behavioral control or influence over the worker. Another one is, financial dependence and what is the financial relationship? And the last one is looking at the actual type of relationship between the worker and the business. So those three aspects, each of them have questions that the analysis seeks to have answered.

Let's look at behavioral first. Now the behavioral aspects or considerations of the IRS test, essentially look at the type of instructions given to employees and the amount of instructions. Additionally, to what extent and how is a worker evaluated and trained and all of those types of issues are very important. The more training that you give a person in terms of how something is done, the less likely it is that they could be found to be a independent contractor because you are definitely exerting pressure on specifically the procedures to get the end result.

Independent contractors really are contracted for an end result and when you give instructions, significant instructions, a lot of instructions, you evaluate progress based upon your instructions and you go through extensive training on how to accomplish a specific task for a worker, those types of considerations all lean towards that worker being held to be an employee as opposed to an independent contractor

Another consideration, of course we said, was the financial considerations. Financial considerations are things like the amount of investment expenses and the degree to which they reimburse, loss and profit opportunity, abilities to service the marketplace and not just this particular business and how are they paid. If they're paid consistent with payroll that might be analyzed much differently than if the worker is invoicing on a monthly basis. If the worker has to invest in its own equipment and supplies in order accomplish an end result and be paid for the end result, then that bodes well for the idea that that worker may be an independent contractor. So these are the factors that the IRS looks at when analyzing financial considerations and making a determination as to the classification work.

The third part is the type of relationship and sort of looking at what evidence there is that gives guidance as to the type of relationship. Was there a written contract and did it spell out enough details with regards to the end result for the say that the idea here is that this person is being contracted to meet the results. Usually independent contractors are hired on a episodic or a case by case basis to take care of a specific project or need and if that's the case then that bodes well for this particular worker being determined to be an independent contractor. But if there's no end date, if you're contracting for a result that is ongoing, then arguably that relationship has more permanency than an event and, in that case, the analysis might favor the worker being held to be an employee. So those are factors that are looked at that are all key.

Now I talked in a prior lecture about the economics realities tests and I just now outlined the major questions asked by the

IRS and the three main categories of the IRS analysis. The two tests generally have a lot of overlap and what's difficult about this whole analysis is that, there's not a single overriding factor. But I think it's fair to say that in both the economic realities test and the IRS test, the biggest aspect of it is degree of control that the business exercises over the worker. Now, some jurisdictions look at and they create hybrids between the economics realities tests and the IRS test so that even complicates this analysis further for businesses in terms of properly classifying people. If you're going to err one way or the other, it is probably more conservative and safe to err on the side of designating workers as employees and paying the taxes and benefits to avoid liability. But if you believe that the worker is an authentic contractor. You've gone through a good faith analysis of how they're managed, how they're going to be dealt with in terms of the degree of control, the results being contracted for and you do a, a masterful job of crafting a clear, independent contractor agreement, all of those things can help considerably in making sure that a independent contractor is designated as such appropriately. And, therefore, you can avoid some of those additional liabilities for from the benefits of the governments, you know, taxes and things that nature.

Mark Addington


Mark Addington

Mark A. Addington, Esq. advises and advocates on behalf of businesses concerning Labor & Employment Law, Business Regulatory Compliance, Restrictive Covenants (Non-Competition, Non-Solicitation, and Confidentiality), Wage & Hour, Privacy, Technology,...

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