In most scenarios involving an individual performing labor or a service for another party, the relationship between the two parties is cleanly delineated. For example, if Company hires an Individual as a file clerk, pays the Individual an hourly wage, and expects to see the Individual on a daily basis, Individual is most likely an employee. On the other side of the coin, if Company hires that same Individual to clear a clogged drain, pays Individual for the service, and doesn’t expect Individual to return another time, Individual is usually described as an independent contractor.
The problem that companies face is that the situation is not always so clearly cut. It’s more than just a titling issue; the relationship between Company and Individual rolls over into labor, taxation, and liability issues, among others. Your requirement, as the hiring entity, is to get it right from the start – but how do you do it? It’s easy to say that you hire employees to work on your behalf and retain independent contractors to deliver services for your benefit, but it’s not enough.
Take, for example, the scenario of a courtesy patrol officer. In exchange for a payment equal to his apartment’s monthly rent, he’s expected to patrol the community four nights out of an eight-night period. Is he an employee or independent contractor?
How do you tell which relationship exists? Ironically, not even the government has a bright-line rule for the difference between an employee and an independent contractor. The IRS has a set of guideline questions, however, that help to sort out this issue:
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer?
3. Type of Relationship: Are there written contracts or employee-type benefits? Will the relationship continue and is the work performed a key aspect of the business?
“Independent Contractor (Self-Employed) or Employee?,” Internal Revenue Service, U.S. Department of the Treasury. irs.gov. These questions will help tilt the scales in one direction, but the IRS still acknowledges that there is no “magic number” of answers that will make the answer definitive.
Behavioral
The first aspect is that of control over Individual’s work. If Company has the right in the relationship to set work hours, number and duration of breaks, and overtime, then the scale tilts toward “employee.” Likewise, if Individual is dispatched to specific projects or prioritization is assigned by Company, those tend to indicate “employee.” If the relationship involves freedom to approach the tasks at hand in the manner of his/her choosing and freedom from direct oversight, then the “independent contractor” flags start to rise.
Notice that they’re not guarantees, though. Highly-skilled individuals who lack supervision and have fixed compensation, which are both hallmarks of independent contractors, might be employees. (Example: the Company’s controller, a salaried position.) Prioritization of tasks, an indicator of employer-employee relationships, can easily be demanded of independent contractors as well. (Example: informing the landscapers that the weeds along the property’s edge need to be addressed first due to a Neighborhood Services complaint.)
Perhaps the easiest delimiter to use is that of evaluation. If Company is evaluating the end-result of the project only, then Individual was likely an independent contractor, whereas if Company was evaluating the efforts made during the project, then he/she is likely an employee.
Financial
There are three general aspects to the “financial” question. Those aspects are expenses, opportunity, and marketability.
If Company tends to reimburse Individual for most of the expenses Individual incurs in performing the services, it’s more likely that Individual is an employee. Independent contractors tend to suffer more unreimbursed expenses than do employees, as the relationship between those two parties tends to revolve around a fixed price for the end-result of the service. Similarly, if Individual has the opportunity to profit or, more importantly, take a loss in performing the service, the relationship is likely one of independent contracting.
The item most prone to misleading conclusions is that of marketability. If Individual has the freedom to seek out business opportunities from other parties without jeopardizing his/her relationship with Company, then the relationship tends to be indicative of independent contracting. However, part-time work can still create an employment relationship, as can holding down two full-time positions/assignments.
There’s a fourth indicator, one called “significant investment.” Independent contractors are usually required to supply their own equipment, such as tools, or incur initial capital outlays. However, on a regular basis employees will use their own tools on company projects. This indicator is a difficult one to analyze independently, but as with all other such indicators, it is not a question of a single item but all items together.
Type of Relationship
Finally, we analyze the nature of the relationship itself. Some employment relationships are wholly undocumented, just as are some independent contractor ones. Others have formal contracts, and still others have flexible arrangements. Regardless of the arrangement, calling it an “independent contractor agreement” does not make it independent.
First, the contract’s caption does not control. Instead, the details of the relationship determine the actual status of Individual. If Individual is receiving benefits such as vacation time and health insurance, it is likely an indicator that the relationship is not independent. The reverse is not true, though; some employment relationships provide nothing more than an hourly wage or a tangible benefit.
Last, we look at the term of the relationship. Fixed-project terms tend to indicate that the relationship is an independent contractor, whereas open-ended ones indicate employment.
As I indicated above, the three questions the IRS provides are designed to help analyze the relationship between the Company and the Individual. Like a lot of legal questions, the answer depends on the analysis of the details. In the employment arena, you need to be certain that your “independent contractor” is really independent, or you’ll face consequences for your improper designation.
Now that you’ve reviewed these topics, can you answer the question posed at the beginning? If you find that the answer isn’t perfectly clear, then be certain to contact your attorneys – it’s your best practice when faced with negative consequences like IRS audits, Industrial Commission of Arizona complaints, and the like.
Paul A. Henderson is an attorney with the Law Offices of Scott M. Clark, P.C.. He can reached at 602.957.7877.
The views expressed here are generalized advice or information. Fact-specific questions should always be referred to legal counsel. Statements and opinions expressed in these legal columns are solely those of the author or authors. This advice does not necessarily represent the views or opinions of the Arizona Multihousing Association.
