How the IRS determines employment status

Hint: It’s not cut and dried

Designating the employment status of a worker–whether they’re a 1099 independent contractor or a W-2 employee–is a straightforward exercise, right?  With the Internal Revenue Service (IRS) paying such close attention, you’d think it would be.  However, you’d quickly discover that there is no one straight path to determining your hiree’s employment status.

To provide clarity, the IRS initially issued Revenue Ruling 87-41.  It provided a list of 20 “factors” to guide employers in making the determination of whether an employer-employee relationship exists.  More recently, the IRS consolidated these into three general categories:

• Behavioral Control
• Financial Control
• Relationship of the Parties.

Not all factors are equal, or even applicable.  The facts and circumstances regarding the relationship and services performed influence the relative importance of each one.

When taking into account this list, the overarching factor that ultimately determines classification is the “right of control.”  If the employer has the right to direct what, when, where and how the job is done, it’s likely a W-2 relationship exists.  Conversely, if a worker has an established business, multiple clients and uses their own equipment, they’re likely an independent contractor.

These are the 20 factors listed in the IRS ruling and covered in the three categories above.

1. Instructions: If the person for whom the services are performed has the right to require compliance with instructions, this indicates employee status.
2. Training: Worker training (e.g., by requiring attendance at training sessions) indicates that the person for whom services are performed wants the services performed in a particular manner (which indicates employee status).
3. Integration: Integration of the worker’s services into the business operations of the person for whom services are performed is an indication of employee status.
4. Services rendered personally: If the services are required to be performed personally, this is an indication that the person for whom services are performed is interested in the methods used to accomplish the work (which indicates employee status).
5. Hiring, supervision, and paying assistants: If the person for whom services are performed hires, supervises or pays assistants, this generally indicates employee status. However, if the worker hires and supervises others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, this indicates independent contractor status.
6. Continuing relationship: A continuing relationship between the worker and the person for whom the services are performed indicates employee status.
7. Set hours of work: The establishment of set hours for the worker indicates employee status.
8. Full time required: If the worker must devote substantially full time to the business of the person for whom services are performed, this indicates employee status. An independent contractor is free to work when and for whom he or she chooses.
9. Doing work on employer’s premises: If the work is performed on the premises of the person for whom the services are performed, this indicates employee status, especially if the work could be done elsewhere.
10. Order or sequence test: If a worker must perform services in the order or sequence set by the person for whom services are performed, that shows the worker is not free to follow his or her own pattern of work and indicates employee status.
11. Oral or written reports: A requirement that the worker submit regular reports indicates employee status.
12. Payment by the hour, week, or month: Payment by the hour, week, or month generally points to employment status; payment by the job or a commission indicates independent contractor status.
13. Payment of business and/or traveling expenses: If the person for whom the services are performed pays expenses, this indicates employee status. An employer, to control expenses, generally retains the right to direct the worker.
14. Furnishing tools and materials: The provision of significant tools and materials to the worker indicates employee status.
15. Significant investment: Investment in facilities used by the worker indicates independent contractor status.
16. Realization of profit or loss: A worker who can realize a profit or suffer a loss as a result of the services (in addition to profit or loss ordinarily realized by employees) is generally an independent contractor.
17. Working for more than one firm at a time: If a worker performs more than de minimis services for multiple firms at the same time, that generally indicates independent contractor status.
18. Making service available to the general public: If a worker makes his or her services available to the public on a regular and consistent basis, that indicates independent contractor status.
19. Right to discharge: The right to discharge a worker is a factor indicating that the worker is an employee.
20. Right to terminate: If a worker has the right to terminate the relationship with the person for whom services are performed at any time he or she wishes without incurring liability, that indicates employee status.

Still in doubt about employment status?  Ask the IRS.

If you’re still unsure and would like assistance determining a worker’s employment status, you can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.  You’ll find many of the factors above listed in the questionnaire.  Once the form is submitted, the IRS will assign a technician to review the factors, seek additional input if necessary and apply the law.  Typically the technician will issue a determination letter to the payer (employer).  The worker will be copied on the determination letter, too.

Of course, HR Support Services can help answer questions about the correct classification as well.