One of the trickier questions of business law is the characterization of an individual as an independent contractor or an employee. Many business owners wonder whether they are categorizing their workforce correctly or exposing themselves to potential liability for unpaid employment taxes to the IRS by mischaracterizing employees as independent contractors. The determination of whether an individual is an employee or an independent contractor depends on the particular facts of each situation. However, there are some general factors the courts look to in making this determination.
If It Walks Like a Duck…
Although not exhaustive, some of the main factors used to determine whether an individual is an employee or an independent contractor are:
- the extent of control the business has over the work performed by the individual;
- whether a formal contract is in place;
- the permanency of the relationship;
- whether the business provides any training;
- the individual’s investment in facilities or tools;
- whether the business reimburses expenses;
- how and when the individual is paid;
- whether the business provides any employment benefits;
- the individual’s ability to make a profit or loss;
- whether the arrangement is exclusive;
- whether the individual holds his or her services out to the public; and
- how integral the services are to the business as a whole.
While none of these factors is the exclusive determining consideration, the single most important consideration is the business’s right to control the work performed by the individual and, to a lesser extent, the degree of control actually exercised. The more control the business has over how the individual completes his or her work, the more likely the individual is to be deemed an employee. This makes sense if you consider it on a larger scale. If you hire an outside company (rather than an individual) to perform a service, your primary focus is on the results of that service. You likely have very little control over how the company’s workers dress, what they say, their methods and techniques, their timeliness (or lack thereof) each day, or any other individual aspect of how they do the job. Your only real concern is what gets done and when it is complete. You hire the company to perform a task (or set of tasks), and you pay them for its proper completion.
The courts think much the same way when determining an individual’s status. If the company has the right to control the details of how an individual’s work is done, even if the company doesn’t feel the need to stringently exercise that control, the individual looks much more like an employee than an independent contractor. Conversely, if the company has no right to determine or control the individual’s methods, the individual seems far more independent. In the end, the courts try to determine, considering the situation as a whole, which label more truly describes the relationship.
The Importance of Using a Written Contract for Independent Contractors
In many situations, the desired relationship is truly that of employer/employee and it should be characterized as such. However, parties that intend to form an independent contractor relationship often take actions that inadvertently change the analysis. In these situations, a written contract is extremely important. A formal agreement may only be one factor in the analysis of the courts, but using a written contract can go a long way in helping you meet the other relevant factors. Not only can a contract clearly state the intention of the parties, it can also define the roles and the rights of each party, bringing more clarity to the overall analysis. The factors considered by the courts can be addressed in a contract, declaring from the outset what the rights and obligations of each party are.
Although greatly helpful in clarifying the relationship, a contract cannot overshadow the actual conduct of the parties. If the parties act as employer/employee, the courts will characterize the relationship as such, no matter what the parties claim. However, a contract can help define the relationship for both the courts and the parties and can guide the parties’ conduct to avoid actions that unintentionally create an employer/employee relationship. — Collin Atkins