Worker classification is an ongoing issue for most employers. Unfortunately, misclassification of workers can result in substantial liability for employers, with such liability arising in many different ways.
Recently, governmental agencies such as the Internal Revenue Service (IRS), Department of Labor and state taxing agencies have been aggressively taking enforcement action against employers with respect to worker classification issues. As such, it is advisable for employers to review their treatment of independent contractors and to become familiar with the IRS’s three-pronged worker classification test.
The IRS test focuses on three main categories: behavioral control, financial control and the relationship between the parties. With respect to behavioral control, the IRS will consider whether an employer controls (or has the right to control) what the worker does and how he or she performs his job. If the employer controls or has the right to control how the services are performed, the worker will most likely be considered an employee.
In looking at financial control, the IRS will look at whether the worker has a significant financial investment in his or her business, accompanied by the opportunity to generate a profit or loss from the business.
Finally, the IRS will consider whether there are written agreements in place between the employer and the worker indicating intent as to the status of the worker, and how the employer treats the worker with respect to its benefit plans.
The following are some “best practices” for an employer to follow if it uses independent contractors:
■■ Set own schedule. Workers should be allowed to set their own hours and work days. A schedule that is imposed by the employer, by which a worker is required to abide, can be problematic.
■■ Ability to Decline Projects/Assignments. Independent contractors should have the option to accept or decline a particular project or assignment. The right to reject an assignment is a key component of an independent contractor relationship.
■■ Setting rates. Workers who are independent contractors should set the rates for their services. The general rule is that independent contractors should negotiate their rate of pay directly with their clients. Whether the company or the worker sets the rates to be charged is one of the key factors the IRS considers under its behavioral control test.
■■ Reimbursement of expenses. Companies should avoid reimbursing independent contractors for their expenses, when possible. One characteristic of an independent contractor relationship is that the worker provides his or her own tools necessary to perform the services and bears his or her own costs and expenses associated with operating his or her business.
■■ Training. Companies should avoid providing specific instructions or training to independent contractors as to how to perform their services. Required meetings for workers characterized as independent contractors should also be avoided.
■■ Hiring Assistants. The ability of an independent contractor to hire third parties to assist him or her in performing the required services is indicative of an independent contractor relationship.
■■ Attire. Companies should avoid requiring workers characterized as independent contractors to wear uniforms or clothing with a company logo. General dress and grooming standards can in certain cases be acceptable, but a requirement that uniforms be worn is problematic.
■■ Outside services. Workers treated as independent contractors should be free to provide services to others, unless the provision of such services is inconsistent with the worker’s services being provided to the company.
■■ Benefits. Companies should not provide employee benefits such as sick leave, vacation pay or 401(k) participation to any worker treated as an independent contractor.
■■ Written agreement. Companies should enter into a written independent contractor agreement with workers and have that agreement carefully reviewed by legal counsel to confirm that it puts the company in the best position possible if the worker’s status as an independent contractor is challenged.
■■ Evidence of independent business. Whenever possible, it is helpful if the company has obtained evidence that the worker considers himself or herself to be operating an independent business. Such evidence can be through business cards, a business license, the formation by the worker of a limited liability company or corporation through which the services are provided, or otherwise.
Cindy Strom Arellano is head of the firm's business and tax team. Her practice focuses on employee benefits and executive compensation, qualified and non-qualified deferred compensation and retirement plans, health and welfare ...
- Of Counsel
Lisa Zaradich practices primarily in the areas of business transactional law, advising both nonprofit and for-profit organizations, and resolution of tax controversy, including audits and assessments by the IRS, EDD, FTB, and ...
Other AALRR Blogs
- Ninth Circuit Voids “No Re-Hire” Provision in Settlement Agreement Between Employer and Former Employee
- The Tale of Three Presumptions
- Ninth Circuit Provides Guidance for Likelihood of Irreparable Harm in Trademark and Trade Dress Cases, But Questions Still Loom for the Role of Evidence of Likelihood of Confusion
- Don’t Wave the White Flag: The General Mills TTAB Decision Is Not a Pink Slip for Protection of Trade Dress that Includes Color
- General Data Protection Regulation Effective May 25, 2018
- Employers Using Third Party Payroll Providers May be Held Liable for Unpaid Taxes
- Financial Elder Abuse And Business Transactions
- You’ve Settled Your Employee’s Harassment Claim – Now, is it Deductible?
- IRS Posts 2018 W-4 and Encourages Taxpayers to Use New Withholding Calculator
- Website Access For The Visually-Impaired