Independent Contractor or Employee?

Depends on Who is Asking

Hiring employees adds a new level of complexity to your new or small business.

Suddenly, you have to be concerned with issues like worker’s compensation, withholding taxes, employment security, pension, and health care, to mention just a few. Some business owners try to minimize the employment complexities by hiring independent contractors instead of employees.  But the distinction between employees and independent contractors can be unclear and even variable depending on the circumstances.  A written agreement between the business and the supposed independent contractor does not settle the matter.

In very general terms, a person is an employee if the business has the right to control the details of the work performed.  For example, an office helper that reports to a company supervisor or owner is fairly clearly an employee.  On the other hand, a person who comes in regularly to service your copy machine is an independent contractor.  However, there is a vast gray area between the obvious extremes where it can be difficult to determine whether a person is an independent contractor or an employee.

To add to the confusion, he or she may be considered an employee by some agencies and an independent contractor by others.  Different agencies have different tests for determining whether a person is an employee or an independent contractor.  The Washington Department of Labor and Industries has standards which differ from the Department of Employment Security.  The Internal Revenue Service also has its own guidelines.  Claims under various federal employment statutes face still other tests.

The federal IRS guidelines for defining employees and contract workers are quite comprehensive, and can help you get a better idea of what agencies take into consideration when defining a worker’s status.  As an aid for determining whether an individual is an employee under the common law rules, the IRS identified 20 factors which can indicate whether or not sufficient control is present to establish an employer-employee relationship:

  1. employee compliance with instructions required,
  2. training,
  3. integration of worker’s services into the business,
  4. services are rendered personally,
  5. ability to hire, supervise and pay assistants,
  6. a continuing relationship,
  7. set hours of work are established,
  8. full time is required,
  9. work performed on business’s premises,
  10. services performed in a set order or sequence,
  11. oral or written reports required,
  12. payment by hour, week or month,
  13. payment of business and/or travel expenses,
  14. tools and materials furnished,
  15. worker invests in facilities,
  16. worker can realize a profit or loss,
  17. worker performs services for more than one business at a time,
  18. worker makes services available to the general public,
  19. business has the right to discharge worker, and
  20. worker has the right to terminate the relationship

The above 20 factors are discussed in more detail in a 1987 IRS Revenue Ruling (Rev. Rul. 87-41).

Even if the parties sign a written agreement stating that the worker is an independent contractor, the courts will look to the actual dynamics of the relationship to determine whether a person is an independent contractor or an employee for the purposes at hand.  A leading case is Vizcaino v. Microsoft where Vizcaino and others had written agreements stating that they were independent contractors. Vizcaino and others later challenged the independent contractor label and established that they were, in fact, employees and entitled to employee benefits.  Microsoft paid over $98 million in past benefits going back many years.

If you are considering hiring independent contractors and, due to the nature of the work, there is any question that your independent contractor could be defined as an employee, it will be helpful to discuss the issue with an appropriate professional.  There may be steps that can be taken to make it more likely that a person will be considered an independent contractor by all agencies concerned.  Failure to make this distinction clear could be very costly if “independent contractors” are found to be employees, who may be able to make a claim for past benefits and taxes.