Mistake 1: Not considering all aspects of the company-worker relationship
To properly classify your workers, you must consider all aspects of the worker-company relationship. You shouldn’t base your classification decision on only one factor.
After all, the U.S. Supreme Court has, on a number of occasions, indicated that there is no single rule or test for determining whether a worker is an employee or contractor. The court has stated that it’s the total activity or situation that controls the classification.
In determining whether a worker is an employee or contractor, evaluate the amount of control over the details of the work performed.
- The more control a company exerts, the more likely it is that the worker is an employee.
- When a company exerts almost no control, then it’s more likely a worker is an independent contractor.
3 categories that the IRS considers
1. Behavioral: Does the company have the right to direct or control how a worker does the work?
Consider whether workers receive extensive instructions on how work is to be done. Examples:
- Hours and location of work
- Tools and equipment to use
- Who to hire to help assist with the work
- Where to purchase supplies
Also consider whether a company provides a worker with training about procedures and methods.
If a company gives detailed instructions and provides training, that’s a good indication the worker is an employee.
2. Financial: Does the company have the right to direct or control the business part of the work?
Look at these factors:
- How much money – known as a significant investment – has a worker invested into their work using their own money? (Note: There’s no precise minimum dollar amount required. Significant is open to interpretation.)
- Is a worker reimbursed by the company for their expenses associated with their work?
- Does the worker realize a profit or incur a loss?
A worker spending their own money and not receiving reimbursement, and incurring profits and losses, is indicative of a contractor.
3. Type of relationship: What are the facts that demonstrate how the company and the worker perceive their relationship?
Does the worker receive employee benefits, such as insurance, retirement savings plans or a pension and paid leave?
If a worker receives benefits, they’re an employee. However, as we’ll discuss later, if a worker doesn’t receive benefits, they could be either an employee or a contractor.
Is there a written contract describing the relationship?
The U. S. Supreme Court’s criteria
To further clarify, the U.S. Supreme Court has listed these factors as significant in classifying workers:
- The extent to which services rendered are an integral part of the company’s core business
- The permanency of the relationship
- The amount of the worker’s investment in facilities and equipment
- The nature and degree of control by the company
- The worker’s opportunity for profit and loss
- The amount of initiative, judgment or foresight in open-market competition with others that’s required for success
- The degree of independent business organization and operation
How does this play out in real life?
Now let’s use an example. Upon discovering a plumbing issue in their facility, Waffle World hires Bill Jones, a local plumber, to unclog their drains.
Based on these facts, how should Bill be classified?
- Bill’s work is completely different than Waffle World’s core business.
- Waffle World has little control over the behavioral aspects of his job (what he does and how he does it).
- Bill owns and pays for his own equipment.
- This isn’t a one-time job for Bill. Waffle World decides to hire Bill to return once per month to flush the company’s drain, and pays him $600 per month for this service.
Answer: Bill should be classified as an independent contractor.
However, if Waffle World considered only his recurring employment and monthly wage, he could be wrongly classified as an employee.
Mistake 2: Basing worker classification solely on written contracts
Mistake 3: Improperly defining a “significant investment”
Mistake 4: Paying employees and contractors similarly
Mistake 5: Viewing benefits as the determining factor
Mistake 6: Relying on industry standards
Read the full story at Employee or Contractor? 6 Mistakes When Classifying Workers – Insperity