The common-law-rules as defined by the IRS can help business owners determine whether their workers are considered employees or contractors. It is crucial for business owners to make this determination because each classification is subject to different tax withholdings and laws.
A business owner may do this by considering the degree of control over the worker, and also the nature of the relationship with the worker. The IRS defines this by three categories: behavioral control, financial control, and the type of relationship between the business and worker.
Behavioral control refers to how much the business owner controls how the worker does his or her job. Behavioral control is further classified by the IRS by four categories:
1.) Type of Instructions Given – Does the business mostly determine when, where, and how to work? Contractors have a greater degree of control over these details.
2.) Degree of Instruction – In general, the more detailed and elaborate the instructions are that the business gives the worker, the greater the chance that the worker is an employee.
3.) Evaluation System – If there is some kind of ongoing job or work evaluation system, the worker is likely an employee.
4.) Training – If there is detailed job training, it points to the fact that the business owner wants the job done in a very specific way. Also, if there is continual training during the worker’s tenure, then the worker is likely an employee.
Financial control refers to how much the business owner controls all of the financial circumstances of a worker’s job. This control falls into five categories:
1.) Significant Investment – Does the worker purchase his or her own equipment? Generally, independent contractors purchase their own equipment.
2.) Unreimbursed Expenses – Independent contractors have more unreimbursed expenses than employees.
3.) Opportunity for Profit or Loss – Independent contractors have a greater potential to lose money on their contracts. For example, the cost of equipment for a job might be more than the contractor’s earnings for that job.
4.) Services Available to the Market – An independent contractor is allowed to have his or her own individual freedom to market their business or service. Many employees are not.
5.) Method of Payment – Many employees are paid hourly and guaranteed a specific wage per hour. Independent contractors can be paid hourly or with a flat fee.
Type of relationship refers to the details on the perception of the relationship between the business and worker. The categories that determine type of relationship are as follows:
1.) Written Contracts – Even though a contract may state whether a worker is an employee or contractor, the IRS is not obligated to agree with this classification.
2.) Employee Benefits – Employees are more likely to have benefits like paid vacation, sick leave, health insurance, and others.
3.) Permanency of the Relationship – Employees are more likely to be hired on an indefinite basis, whereas independent contractors are generally hired for fixed terms.
4.) Services Provided as a Key Activity of the Business – Employees that provide services such as consulting or advice are still mostly under the control of their employers.
With these common-law-rules, businesses can make a reasonable guess to what their workers are classified as. Again, if there is any question, the IRS will make the official classification from form SS-8.
