IRS Factor Explanations
Internal Revenue Service (IRS) Revenue Ruling 87-41 contains factors, commonly referred to as the 20 common law factors, that are used to assess whether a worker is an employee or an independent contractor for employment tax purposes. Although this revenue ruling is still valid today, the IRS has grouped the more relevant ones into the following three main categories of evidence that show whether a worker is an employee or independent contractor:
Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training, or other means.
Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.
Type of Relationship covers facts that relate to how the worker and the business owner perceive their relationship.
In each case, employers must consider all the facts and factors because no single fact will provide an absolute determination as to whether a worker is an independent contractor or an employee.
1. Is the worker required to comply with your instructions about when, where, and how his or her services are to be performed?
This is a very important factor.
If your business has the right to control or direct not only what is to be done, but also when, where, and how it is to be done, then the workers are most likely employees. If your business can direct or control only the result of the work done — and not the means and methods of accomplishing the result — then the workers are probably independent contractors.
Types of instructions include things like:
When and where to do the work
What tools or equipment to use
What workers to hire or to assist with the work
Where to purchase supplies and services
What work must be performed by a specified individual, and
What order or sequence to follow when performing the work
The more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.
Independent contractors are free to do jobs in their own way, using specific methods they choose. A business engages an independent contractor for the job’s end result. When a worker is required to follow company procedure manuals and/or is given specific instructions on how to perform the work, the worker is normally an employee.
2. Does your business provide the supplies, materials, equipment, and other tools necessary to perform the work?
The furnishing of tools, materials, etc., by the employer indicates control over the worker.
Independent business people furnish the tools, equipment, and supplies needed to perform the work. Independent contractors normally have an investment in the items needed to complete their tasks. When a worker furnishes tools and materials, especially when a substantial sum is involved, there is an indication of independence.
3. Is the worker required to perform the services personally and not delegate the tasks?
An employee’s services must be rendered personally; employees do not hire their own substitutes or delegate work to them. A true independent contractor is able to assign another to do the job in his or her place and need not perform services personally.
4. Is the worker required to perform the services on your business’ premises?
Doing the work on the employer’s premises, on a route, or at a location designated by an employer implies employer control, especially where the work is of such a nature that it could be done elsewhere.
Doing work away from the employer’s premises when it could be done on the premises indicates some degree of freedom from control, especially when the work is free from supervision.
5. Is the worker required to undergo company-provided training about procedures and methods so that the work is performed in a particular manner and with a particular result?
“Training” means explaining detailed methods and procedures to be used in performing a task. If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Training can be as informal as requiring the worker to attend meetings or work along with someone who is more experienced. Periodic or ongoing training about procedures and methods is even stronger evidence of an employer-employee relationship.
An independent contractor uses his or her own methods and thus need not receive training from the purchaser of those services.
6. Is the worker required to submit regular oral or written reports?
The submission of regular oral or written reports indicates control since the worker must account for his or her actions.
An independent contractor is usually not required to submit regular oral or written reports about the work in progress.
7. Does your business have the right to hire, fire, supervise, or pay assistants of the worker?
A worker performs services for an employer who hires, supervises, and pays assistants. If a worker hires and supervises assistants at the direction of the employer, he or she is acting as an employee in the capacity of a foreman for, or representative of, the employer.
An independent contractor hires, supervises, and pays assistants under a contract that requires him or her to provide materials and labor.
8. Does the worker provide you services without maintaining a separately established business offering similar services to the market?
When individuals hold themselves out to the general public as available to perform services similar to those performed for an employer, it is evidence that the individuals are operating separately established businesses and would normally be independent contractors. This may be evidenced by the worker:
Having an established business.
Advertising in the electronic and/or print media.
Maintaining a listing in the commercial pages of the telephone directory.
Using business cards, business stationery, and billheads.
Maintaining a place of business and making a significant investment in facilities, equipment and supplies.
Paying one’s own expenses.
Assuming risk for profit or loss in providing services.
Determining one’s own schedule.
Setting or negotiating own pay rate.
Providing services concurrently for other businesses, competitive or noncompetitive.
Being free to refuse work offers.
Being free to hire help.
If a worker performs services for only one person, does not advertise his or her services to the general public, and performs services on a continuing basis, it is an indication of an employment relationship.
9. Is the worker paid a fixed salary, an hourly wage, or based on a piece rate basis?
The method of payment may be helpful in determining whether the worker has the opportunity for profit or loss.
A worker who is compensated on an hourly, daily, weekly, or similar basis is guaranteed a return for labor. This is generally evidence of an employer-employee relationship, even when the wage or salary is accompanied by a commission.
Performance of a task for a flat fee is generally evidence of an independent contractor relationship, especially if the worker incurs the expenses of performing the services. When payments are made (daily, weekly, or monthly) is not relevant.
10. Does your business reimburse the worker’s business and travel expenses?
If the employer pays a worker’s business and travel expenses, the worker is generally an employee. An employer who is able to control expenses also generally retains the right to regulate and direct the worker’s business activities.
A worker who is paid on a job basis and who has to take care of all incidental expenses is generally an independent contractor. Since the person is accountable to no other person for the expenses, the person is free to work according to his or her own methods and means.
11. Is the investment made by the worker in order to perform the services minor or relatively small compared to the investment of the business?
A significant investment is evidence that an independent contractor relationship may exist.
12. Is the worker unable to make business decisions that would result in the worker earning a profit or incurring a financial loss?
The ability to realize a profit or incur a loss is probably the strongest evidence that a worker controls the business aspects of services rendered.
When workers are insulated from loss or are restricted in the amount of profit they can gain, they are usually employees. The opportunity for higher earnings by working longer hours, pay on a piecework basis, or the possibility of gain or loss from a commission arrangement, is not considered profit or loss.
An individual is normally an independent contractor when he or she is free to make business decisions which impact his or her ability to profit or suffer a loss. This involves real economic risk, not just the risk of not getting paid.
Whether a profit is realized or loss suffered generally depends on management decisions; that is, the one responsible for a profit or loss can use his or her own ingenuity, initiative, and judgment in conducting the business or enterprise.
These decisions would normally involve the acquisition, use, and/or disposition of equipment, facilities, and stock in trade which are under his or her control. Further examples of the ability to make economic business decisions include the amount and type of advertising for the business, the priority in which assignments are worked, and selection of the types and amounts of insurance coverage for the business.
Independent contractors typically can invest significant amounts of time or capital in their work without any guarantee of success.
13. Is the worker prohibited from performing similar services for other businesses at the same time?
Work for a number of businesses at the same time usually indicates an independent contractor status because the worker is usually free, in such cases, from control by any of the businesses.
Relationship of the Parties
14. Is your business providing employee-type benefits to the worker?
Employee benefits include things like life or disability insurance, pension plans, paid vacation, and paid sick days. Businesses generally do not grant these benefits to independent contractors. The evidence is strongest if the worker is provided with employee benefits under a tax-qualified retirement plan, IRC section 403(b) annuity, or cafeteria plan, for, by statute, these employee benefits can only be provided to employees.
15. Are the services provided a key activity or part of your regular business activity?
If a worker provides services that are a key aspect of your regular business activity, it is more likely that the employer will have the right to direct and control the worker’s activities. For example, a baker is a key element in the bakery business. It is likely that the bakery would have the right to control or direct that work of the baker because his or her success determines the success of the bakery. This would indicate an employer-employee relationship.
On the other hand, a plumber engaged to fix the pipes in the bathroom of a store is performing a service on a onetime or occasional basis that is not an essential part of the purpose of the business enterprise. A certified public accountant engaged to prepare tax returns and financial statements for the business would also be an example of an independent contractor.
16. Can the worker be discharged at any time without risking a lawsuit?
If a business has the right to discharge an individual at will and without liability, that worker is considered an employee. The employer exercises control through the ever-present threat of dismissal, which causes the worker to obey instructions.
An independent contractor cannot be discharged without liability as long as he or she produces a result that measures up to his or her contract specifications.
17. Can the worker quit at any time without risking a lawsuit?
The right to quit at any time without incurring liability indicates an employer/employee relationship.
Independent contractors usually agrees to complete a specific job, and are responsible for its satisfactory completion or are legally obligated to make good for failure to complete the job. They are not free to quit or walk away until the job is complete.
18. Does your business have employees who do the same type of work?
If the work being done is basically the same as work that is normally done by employees, it indicates that the worker is an employee. This applies even if the work is being done on a one-time basis. For instance, to handle an extra workload or replace an employee who is on vacation, a worker is hired to fill in on a temporary basis. This worker is a temporary employee, not an independent contractor.
19. Did your business engage the worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period?
If an employer hires a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
The relationship between an independent contractor and his or her client ends when the job is finished.
If the worker continues to be paid during down periods, this points toward a more permanent employer-employee relationship.
If the arrangement consists of continuing or recurring work, the relationship is considered permanent, even if the services are rendered on a part-time basis, are seasonal in nature, or if the person actually works for only a short time.
The following four scenarios illustrate the application of the IRS Test factors:
An attorney or accountant who has his or her own office, advertises in the yellow pages of the phone book under “Attorneys” or “Accountants,” bills clients by the hour, is engaged by the job or paid an annual retainer, and can hire a substitute to do the work is an example of an independent contractor.
An attorney or accountant who is employed by a firm to handle their legal affairs or financial records, works in an office at the firm’s place of business, attends meetings as needed, and the firm bills the clients and pays the attorney or accountant on a regular basis is an example of an employee.
An auto mechanic who has a station license, a resale license, buys the parts necessary for the repairs, sets his or her own prices, collects from the customer, sets his or her own hours and days of work, and owns or rents the shop from a third party is an example of an independent contractor.
An auto mechanic working in someone’s shop who is paid a percentage of the work billed to the customer, where the owner of the shop sets the prices, hours, and days the shop is open, schedules the work, and collects from the customers is an example of an employee.
Dance instructors who select their own dance routines to teach, locate and rent their own facilities, provide their own sound systems, music and clothing, collect fees from customers, and are free to hire assistants are examples of independent contractors.
Dance instructors working in a health club where the club sets hours of work, the routines to be taught and pays the instructors from fees collected from the customers are examples of employees.
A repairperson who owns or rents a shop, advertises the services to the public, furnishes all of the tools, equipment, and supplies necessary to make repairs, sets the price for services, and collects from the customers is an example of an independent contractor.
A repairperson working in a shop where the owner sets the prices, the hours and days the shop is open, and the repairperson is paid a percentage of the work done is an example of an employee.