As I mentioned in a previous post on how we are updating our independent contractor agreements, one of the critical determinants is to figure out whether someone is an employee or an independent contractor. This is important because it determines a Company’s liability to pay and withhold Federal income tax, social security, Medicare, and Federal unemployment tax, as well as potential liability for state based taxes.
Essentially, the tests to determine whether someone is an employee or an independent contractor come down to an issue of control – the more control the Company exerts over the individual, particularly with regard to how the work gets done and how autonomous the individual is in calling its own shots, the more likely the relationship is going to be seen as an independent contractor relationship.
The IRS breaks these elements of control down into three categories in this helpful guide:
- “Behavioral Control – Facts that show whether the business has a right to direct and control the individual.” These factors include the specificity of instructions and training.
- “Financial Control – Facts that show whether the business has a right to control the business aspects of the worker’s job.” To me, these factors go to how financially independent the individual is in terms of its ability to operate its business of providing services to the Company.
- “Type of Relationship – Facts that show the type of relationship,” which include such factors as how long the relationship is intended to last, the written intention of the parties, etc.
In addition to the criteria proposed by the IRS, there are a number of common law criteria used in determining an individual service provider’s status with regard to employment, and individual states have their own guidelines for determining an individual’s status. For example, see California’s guidelines here.
I’ll discuss some very important issues around intellectual propery ownership for independent contractor relationships in a subsequent post.
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