The question of independent contractor or an employee has long been a concern to small businesses. The IRS has changed its guidance significantly over the decades of my career. The most current IRS guidance is perhaps the most complex and subject to interpretation.
In the small business world, classification as an independent contractor often result in the lowest overall amount of taxes and other labor-related expense and so this is often the preferred classification for workers and small business employers. (Those tax advantages are not discussed in this blog post but are a topic frequently covered in this blog). Some small businesses, especially nonprofits, may be restricted from hiring employees by their bylaws. Tax authorities, on the other hand, tend to pus toward classification as employee in order to boost governmental tax receipts. It is important, therefore, for a small business owner to have a strong, clear and documented basis for classification of a worker as a contractor.
IRS considers the degree of control and independence as the basis of determining classification as employee vs. independent contractor. Facts that provide evidence of the degree of control and independence fall into three categories that the IRS calls Common Law Rules. These are the factors considered in the determination of worker classification:
- Type and degree of instruction given
- Evaluation system – work process or end result
- Significant investment
- Unreimbursed expenses
- Opportunity for profit or loss
- Services available to the market
- Method of payment
- Written contract
- Employee benefits
- Permanency of the relationship
- Nature of services provided
None of these factors is controlling in itself. Rather, the entire weight of the evidence must be considered. IRS has been active in using these criteria to reclassify workers as employees and then assessing additional taxes against the employers. Some of those actions may seem excessively aggressive or unfair to employers. I strongly recommend that a small business that uses independent contractors have an independent accountant document these factors to provide future records and evidence for the classification to avoid the risk of future tax assessment.
I would be pleased to discuss a worker classification determination and documentation engagement for your business.