As a Pennsylvania business attorney, I see many businesses make the same mistakes. Misclassification of employees as “independent contractors” is a mistake many businesses make that exposes them to serious risk. In general, a business owner must withhold income taxes, withhold and pay Social Security and Medicare taxes and pay unemployment on wages paid to an employee. A business owner does not generally have to withhold or pay any taxes on payments to independent contractors.
Federal and state authorities make the distinction between an employee and an independent contractor based on whether sufficient control is present to constitute an employer-employee relationship. Control is composed of three primary characteristics: behavioral control, financial control and type of relationship. The Internal Revenue Service has a “20 Factor Test” to help make this determination. The relative degree of importance for each factor can vary considerably depending upon the occupation and the factual context of each particular situation.
Some of the key considerations included in the 20 Factor Test are as follows:
- Continuing Relationship
The existence of a continuing relationship between the worker and the person for whom the services are performed is indicative of an employer-employee relationship. A “continuing relationship” may exist where work is performed at frequently recurring yet irregular intervals. See United States v. Silk, 331 U.S. 704 (1947).
- Set Hours of Work
The establishment of set work hours by the person for whom the services are performed indicates control.
- Employer’s Premises
Work performed on the premises of the person for whom the service is performed suggests control, particularly if the work could be performed somewhere else.
- Payment by Hour, Week, Month
Hourly, weekly or monthly pay schedules are characteristic of an employment relationship. Independent contractors are generally paid on commission or upon project completion.
Other considerations include:
- How integral are the services provided by the individual to the employer’s business?
- How permanent is the relationship between the individual and the employer?
- What amount has the individual invested in facilities and equipment to perform his or her services?
- How much initiative and oversight are required for the individual to be successful?
It is important to remember that the degree of importance of any factor can vary depending on the occupation in question and the factual context in which services are performed. The twenty factors listed by the IRS are designed to serve only as a guide to determine whether sufficient control is present to establish an employer-employee relationship