Baylor University
Tax & Compliance Accounting
Financial Services

Independent Contractor versus Employee Status

Employee Definition

An employee is an individual who is subject to the control and direction of an employer in performing his services as to both the result of his work and the details and means by which that result is accomplished. The description of the relationship by the parties will not control the final determination.

Independent Contractor Definition

An independent contractor is an individual who is subject to the control and direction of another individual only as to the result of his work, not as to the means and details to accomplish such. Under Treasury Regulation 31.3401(c)-1, "physicians, lawyers, dentists, veterinarians, contractors, subcontractors, public stenographers, auctioneers, and others who follow an independent trade, business or profession in which they offer their services to the public" are usually considered independent contractors. If a service requires special skill, any specialist called in to perform the task is usually an independent contractor.

Internal Revenue Service Tests

For many years the IRS used twenty factors to weigh the relationship in question and make its determination as to whether the individual was an employee or independent contractor (see Twenty Factors below). However, in the recent past the IRS issued Publication 1779, Independent Contractor or Employee . . . which detailed three broad categories it now uses to make its determinations. These three categories are:

  • Behavioral Control
  • Financial Control
  • Relationship of the Parties

Behavioral control consists of a determination as to whether the employer has a right to control how the work is accomplished. For example, if the individual receives instructions on "how, when or where to do the work, what tools or equipment to use, what assistants to hire to help with the work, and where to purchase supplies and services," this would usually signal an employer-employee relationship. It should be noted that not all situations that include instructions should be construed as an employer-employee relationship. For example, an individual could give an independent contractor less intensive instructions on at what time and at what place the accomplished work is supposed to be present. Another example of a method used for behavioral control between an employer and an employee is training for required procedures and methods of accomplishing the work given by a company to an individual.

Financial control consists of a determination as to whether the employer has the right to control the financial aspect of the work. Factors that signify an independent contractor relationship include the individual having a significant investment in the work accomplished, the individual not being reimbursed for some or all business expenses, or the fact that the individual can realize a profit or incur a loss on his own.

Relationship of the parties consists of a determination as to how the employer and the individual perceive their relationship. If the individual receives employee benefits, such as insurance or paid leave, this would indicate the individual is an employee. A written contract will be very significant in this determination only if other evidentiary facts are unavailable.

Twenty Factors

The IRS stated in a 2004 Chief Counsel Advice Memorandum that the twenty factors previously used in fact described the three board categories above and could still be used to discover evidentiary facts. There is no magic number of evidentiary facts that will lead to a conclusion; instead all are weighed based on the facts and circumstances of the individual situation. The twenty factors are listed here as taken from Revenue Ruling 87-41 for illustrative purposes:

  1. Instructions to the Worker -- A worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.
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  3. Training -- Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner.
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  5. Integration into Business Operations -- Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.
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  7. Requirement that Services be Rendered Personally -- If the services must be rendered personally, presumably the person for whom the services are performed is interested in the methods used to accomplish the work as well as in the results.
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  9. Hiring, Supervising, and Paying Assistants -- If the person for whom the services are performed hires, supervises, and pays assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor, and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.
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  11. Continuity of the Relationship (permanency) -- A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals.
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  13. Setting the Hours of Work -- The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.
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  15. Requirement of Full-Time Work -- If the worker must devote substantially full time to the business of the person for whom the services are performed, such person has control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses.
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  17. Working on Employer Premises -- If the work is performed on the premises of the person for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises of the person receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.
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  19. Setting the Order or Sequence of Work -- If a worker must perform services in the order or sequence set by the person for whom the services are performed, that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the person for whom the services are performed. Often, because of the nature of an occupation, the person for whom the services are performed does not set the order of the services or sets the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so.
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  21. Requiring Oral or Written Reports -- A requirement that the worker submit regular or written reports to the person for whom the services are performed indicates a degree of control.
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  23. Paying Worker by the Hour, Week, or Month -- Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
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  25. Payment of Worker's Business and/or Traveling Expenses -- If the person for whom the services are performed ordinarily pays the worker's business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker's business activities.
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  27. Furnishing Worker's Tools and Materials -- The fact that the person for whom the services are performed furnishs significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.
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  29. Significant Investment by the Worker -- If the worker invests in facilities that are used by the worker in performing services and that are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship. Special scrutiny is required with respect to certain types of facilities, such as home offices.
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  31. Realization of Profit or Loss by the Worker -- A worker who can realize a profit or suffer a loss as a result of the worker's services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee. For example, if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risk to support treatment as an independent contractor.
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  33. Working for More than One Business at a Time -- If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
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  35. Availability of Worker's Services to the General Public -- The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
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  37. Firm's Right to Discharge Worker -- The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
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  39. Worker's Right to Terminate Relationship -- If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship.
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