The IRS, U.S. Department of Labor, countless other government agencies, and plaintiff's attorneys all over the country know that millions in unpaid taxes and wages -- plus attorney's fees and penalties -- are out there just waiting to be collected. The key to the treasure lies in proving a simple mistake made by employers everywhere: treating workers as independent contractors when they are really employees.
Whether a worker is characterized as an independent contractor or an employee depends in part on the area of law in which the issue arises. The applicable test can vary from one area of the law to the next. Virginia common law, for example, provides one test that applies in cases involving torts, unemployment compensation, and workers compensation. Virginia generally utilizes the "right to control" test to determine whether a person is an employee or an independent contractor. Under the "right to control" test, a person is an employee if the company that hired him or her has the right to control not only the result of the work, but also the means and methods chosen to accomplish that result. In cases arising under federal employment statutes, other law will apply, although many of the principles may be similar.
In the context of federal income tax law, the Internal Revenue Service applies a "right to control" test which includes consideration of specific factors. Historically, the IRS has used twenty factors to assess how particular workers should be characterized. More recently, the IRS has modified its approach such that it considers eleven factors. Consistent with Virginia common law, under the IRS’s test, no one factor is determinative; rather, all the facts and circumstances are considered to determine how the worker should be characterized.
Ultimately, the result of the independent contractor analysis can be significant. For example, in the personal-injury context, employers generally are vicariously liable for injuries to third parties caused by the negligence of their employees. Under unemployment law, employers are obligated to pay unemployment compensation tax to cover workers who are employees. Generally, the federal civil rights and wage-hour statutes apply to employees, but not independent contractors, and income tax treatment and withholding obligations vary depending on whether the worker is an independent contractor or employee.
When determining how to classify particular workers, employers should consider the following specific factors, which are based on the IRS’s factors:
Instructions the business gives the worker. This is probably the most important of all the factors herein listed. An employee generally must obey his employer’s directions concerning when, where, and how to work. On the other hand, an independent contractor generally makes those decisions himself.
Training: Employees are generally trained to perform services in a particular manner, but an independent contractor generally has the training already and is able to deliver the result for the principal.
Reimbursed Business Expenses: Independent contractors operate their own businesses, and thus are less likely to be reimbursed for common business expenses (e.g., gas, meals, traffic tickets, etc.) than employees.
Extent of the Worker’s Investment: An employee usually has no investment in the work other than his or her own time. An independent contractor, on the other hand, often has a significant investment in the facilities he or she uses in performing services for someone else.
The extent to which the worker makes services available to the relevant market: Workers are more likely to be characterized as independent contractors if they are free to work for other companies without retribution or punishment from the principal and if they, in fact, do provide their services to others.
Method of payment: An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. An independent contractor, on the other hand, is often paid by a flat fee for the job.
Extent Employee Can Earn Profit or Loss: The more likely an individual can earn a profit or a loss, the more likely that individual is an independent contractor.
Type of Relationship
Written Contracts: A court is more likely to determine that a worker is an independent contractor if there is a written agreement between the company and the individual that expressly states the individual is an independent contractor.
Employee-Type Benefits: If a company provides its workers with health insurance, a pension plan, or vacation or sick pay, the worker is more likely to be deemed an employee.
Permanency of the Relationship: If the company engages a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is evidence that the intent was to create an employer-employee relationship.
Key Aspect of the Company’s Regular Business: If the services a worker provides to a company are a key aspect of the company’s regular business activity, it is more likely that the company will have the right to control his or her activity.