The IRS, Department of Labor, and many similar state agencies have embarked on a mission to audit more businesses to see if they are improperly classifying their workers as independent contractors. In fact, in 2013, the IRS estimated that millions of U.S. workers were misclassified as independent contractors. (Report of Treasury Inspector General for Tax Administration (June 14, 2013) Reference Number: 2013-30-058: “Employers Do Not Always Follow Internal Revenue Service Worker Determination Rulings”.)

The reason for this growing problem in the United States is simple: just follow the money. On the one hand, employers save money and have less legal responsibility for independent contractors. They save money because they do not pay an employer’s portion of withheld taxes and insurance premiums from the pay checks of independent contractors. On the other hand, the IRS, Workers’ Compensation Commissioners, and Unemployment Offices want to classify as employees as many workers as possible because they get employers to withhold taxes and premiums from employee paychecks. That increases the coffers of governments and simplifies the money collection process.
Each government agency, whether state or federal, has a slightly different test to analyze whether workers are independent contractors or employees. The tests are applied on a case by case basis, and, under any given set of circumstances, one factor may determine the outcome of the analysis.

The IRS is more likely to classify a worker as an independent contractor where the worker:
a) Can earn a profit or suffer a loss from the activity
b) Furnishes the tools and materials needed to do the work
c) Is paid by the job
d) Works for more than one company at a time
e) Invests in equipment and facilities
f) Pays his or her own business and traveling expenses
g) Hires and pays assistants, and
h) Sets his or her own working hours.

IRS is more likely to classify a worker as an employee when the worker:
a) Can be fired at any time
b) Is paid by the hour
c) Receives instructions from the company
d) Receives training from the company
e) Works full time for the company
f) Receives employee benefits
g) Has the right to quit without incurring liability, and
h) Provides services that are an integral part of the company’s day-to-day operations.

In contrast, the Department of Labor follows Supreme Court precedent and has distilled the following factors as having significant importance but, again, may not be the only factors applied:
a) Whether the worker’s services are an integral part of your company’s business (this points to employee status)
b) The permanency of the relationship (the more permanent the relationship, the more likely it is that the worker is an employee)
c) Whether the worker has invested in facilities and equipment (if so, this points to independent contractor status)
d) How much control a company has over the worker (the more control, the more likely it is that the worker is an employee)
e) Whether the worker has opportunities to make a profit or suffer a loss (as opposed to always earning a set amount of money no matter what happens, like an employee)
f) Whether the worker competes in the open market (if so, this points to independent contractor status), and
g) The extent to which the worker operates a truly independent business (the more independence, the more likely the worker is an independent contractor)

In California, the state Supreme Court has adopted related, but still slightly different test. (Borello & Sons, Inc. v. Dept. of Industrial Relations, (1989) 48 Cal.3d 341, 350-51, 354-55.)
a) Whether the one performing services is engaged in a distinct occupation or business;
b) The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
c) The skill required in the particular occupation;
d) Whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work;
e) The length of time for which the services are to be performed;
f) The method of payment, whether by the time or by the job;
g) Whether or not the work is a part of the regular business of the principal;
h) Whether or not the parties believe they are creating the relationship of employer-employee.
i) The worker’s opportunity for profit or loss depending on managerial skill;
j) The permanence of the working relationship;
k) Whether the service rendered is an integral part of the employer’s business.

The IRS has an amnesty program that, under a given set of circumstances, allows an employer to reclassify independent contractors as employees. The program is called Voluntary Classification Settlement Program (VCSP), and it can be a very effective tool for some employers. You can find it on the IRS website. Employers who apply and qualify for that program suffer relatively small penalties in contrast to those employers who do not qualify.

All government agencies are stepping up enforcement, and employers need to carefully analyze the status of their independent contractors to avoid heavy fines, penalties, and back taxes. If you need help with that, please give us a call.

S. Ward Heinrichs, Esq.
Employment Law Office of Ward Heinrichs
4565 Ruffner Street, Suite 207
San Diego, CA 92111
858-292-0792
(858) 408-7543 (fax)