The Common Law Test:
IRS examiners use the 20-factor common law test to measure how much control you have over the worker. These factors are reflected on IRS Form SS-8, (this form can be downloaded at www.irs.gov) “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.”
You can fill out the SS-8, including the facts of your relationship with the worker, and submit it to the IRS to get a determination of whether the worker is your employee or not.
However, many companies simply use the SS-8 as a self-audit to avoid a misclassification trap; they don’t actually submit the form to the IRS.
Of course, many workers — the IRS estimates as many as 85% of all Form SS-8 filers — submit the form to the IRS because they want to contest their treatment as independent contractors.
But the issue of who has the right to control is often not clear-cut, and the Tax Code doesn’t define “employee.” So, the IRS developed the “20-Factor Test” to arrive at an answer. The IRS later refined this test—it added four new, critical factors and added more weight to some and de-emphasized others in the original 20. You don’t need to have all the factors in your favor to be able to treat a worker as an independent, but you are more likely to pass the common law test if the more important factors point to independence.
According to the manual the IRS uses to train its worker classification auditors, the three most important factors are:
Instructions to workers: Your worker is probably an employee if you require him or her to follow instructions on when, where, and how work is to be done. This is a very important factor. However, if you tell your electrician you want blue switch plate covers instead of white, you are not exercising control to a degree that would make the person an employee.
Job training: If your company provides or arranges for training of any kind for the worker, this is a sign you expect work to be performed in a certain way; therefore, the worker is your employee.
Training can be as informal as requiring the worker to attend meetings or work along with someone who’s more experienced.
Worker’s ability to make a profit or suffer a loss: An employee may be rewarded, disciplined, demoted, or fired depending on job performance, but only an independent contractor can realize a profit or incur a financial loss from his or her work. In other words, an employee will always get paid; an independent contractor, however, has a financial stake in his enterprise.
IRS also gives high priority to the following factors:
Intent of your company and of the worker: To build a solid case, you and the worker should sign a written agreement stating the worker is an
independent contractor who will be paid by the job or project, provide his or her own tools, etc.
Pay basis: If you pay a worker on an hourly, weekly, or monthly basis, the IRS will consider it a sign the worker is your employee. An independent is generally paid by the job, project, assignment, etc., or receives a commission or similar fee.
Benefits: Providing benefits other than pay are a strong indicator of employee status. Incorporated status: Workers who are incorporated are generally considered to be working for themselves, not as your employee.
Importance of the worker’s services: If a worker provides services that are integral to the success of your business, the worker is likely your employee.
Personal performance of services: An independent contractor should have the freedom to hire assistants or subcontract work to other workers or firms at his or her expense (this is where profit or loss could enter the picture). If you require the worker to perform the work personally, that’s a
sign of control and therefore indicative of employee status.
Providing assistants: There’s likely an employer-employee relationship if your company hires, supervises, and pays assistants for the worker.
Ongoing relationship: The worker doesn’t have to work for you continuously to be considered an employee; it may be enough if the worker gets assignments at frequently recurring, even if irregular, intervals.
Setting the order or the sequence of the work: If you determine what gets done when, it indicates you control how the work is performed. Allow an independent to decide his or her schedule, both day-to-day and for the longer term.