Coping With Minimum Wage: Independent Contractor vs. Employee
With all the talk about raising minimum wage in California, business owners are trying to get creative and figure out how they're going to stay in business. If a small business is currently paying their employees $15 per hour, then the minimum wage goes up to $15, the person currently making $15 is going to expect a raise to bring them above minimum wage, or else they might go do the much easier minimum wage job (or at least, get their resume in line for it because the competition for those jobs is going to be ferocious). Many employers are looking at the possibility of hiring Independent Contractors instead of Employees. This accomplishes TWO things: Getting them out of paying payroll taxes AND relieves pressure of raising their wage and putting the contractor in charge of how much money they make. With that said, I felt that we better look at the difference between an Employee and an Independent Contractor. Here are the IRS guidelines:
IRS Revenue Ruling 87-41 - Factors for Determining if Independent Contractor Status Applies
This publication was first published in 1987 as a guide to determine a worker's status. It lists 20 criteria to evaluate and determine who is an independent contractor versus who is an employee. The recurring theme throughout the list is "control" of the work performed. This ruling also explains that the way the relationship or the compensation is labeled, described, or designated is irrelevant to determine a worker's actual status.
The entity that controls the worker's activities is the ultimate determining factor. The worker that has more control over the work is more likely to be an independent contractor. On the other hand, if the employer has more control over the work, it is more likely that the worker is an employee. It is extremely important to remember that no single factor is used to make this determination. The entire test should be applied to the situation and the individual responses summarized to arrive at the final determination.
A recap of this ruling with the 20 criteria follows.
A worker who must comply with the compensating entity's instructions with respect to when, where, and how to perform work is an employee. A worker who establishes when, where, and how to perform the work is probably an independent contractor.
A worker who must be trained or who is required to have training to perform the compensating entity's work is probably an employee. Clients do not usually train (and are not usually required to train) independent contractors.
Workers whose services are integrated into and become part of the employer's business operation are probably under the compensating entity's direction and control and are probably employees. Independent contractors do not usually integrate their services into the workflow this way.
4. Services Rendered Personally
The entity for whom a worker personally performs services is usually interested in the methods used and the results attained. This suggests exercising control and that worker is probably an employee. Workers who are not required to personally perform the needed services are probably independent contractors.
5. Hiring, Supervising, and Paying Assistants
The entity that controls hiring, supervising, and paying assistants or helpers usually determines who controls the relationship. If the entity that compensates a worker performs these functions with respect to that worker's helpers or assistants, it is probably an employer and employee relationship. On the other hand, workers who hire, supervise, and pay their assistants are probably independent contractors.
6. Continuing Relationship
Even irregular relationships that recur suggest that it is an employer and employee relationship. Such relationships do not usually occur with independent contractors.
7. Set Hours of Work
A worker is probably an employee if the compensating entity establishes and controls the hours of work. Independent contractors usually control and set their own hours.
8. Full-Time Required
If the compensating entity controls the amount of time a worker spends on the job (which serves to restrict that worker from other contracts or employment), that worker is probably an employee. The opposite applies with independent contractors who usually control their own hours and when and where they work.
9. Doing Work on Employer's Premises
A worker is probably an employee if the compensating entity exercises control over the location of the work, routes traveled, or the territory canvassed. Independent contractors usually work from their own locations and control their own routes and territories but not always.
10. Order or Sequence Set
A worker is probably an employee if the compensating entity controls, sets, or has the right to establish the schedules and routines to be followed. Independent contractors establish their own schedules, routines, and patterns of operation and work.
11. Oral or Written Reports
A worker who must submit either oral or written reports at specified intervals is probably an employee. Independent contractors may occasionally submit periodic reports but are not usually required to do so.
12. Payment by the Hour, Week, or Month
Payments made to workers based on commission or by the job usually suggest an independent contractor relationship. Conversely, payments made to workers by the hour, week, or month usually suggest an employer and employee relationship.
13. Payment of Business and Travel Expenses
An employer and employee relationship is usually characterized by the compensating entity controlling, paying, or otherwise regulating business and travel expenses. This is not the case with independent contractors.
14. Furnishing Tools and Materials
If the compensating entity provides tools and materials to workers, they are probably employees. However, workers who provide their own tools and materials are probably independent contractors.
15. Significant Investment
Workers who invest money into facilities in order to perform a service are probably independent contractors, if the facilities are not the kind an employee usually provides, such as an office or building. However, consideration must be given to cases where employees have offices in their homes to the extent that the employer furnishes those offices.
16. Realization of Profit or Loss
Workers subject to the risk of (or who actually sustain) real economic loss from investments, expenses, and salaries of assistants or hires are probably independent contractors. Employees are not usually exposed to these elements and receive an established specific compensation instead.
17. Working for More Than One Firm at a Time
Workers who control their own circumstances and can or do work for more than one unrelated entity at a time are probably independent contractors. Employees usually work for one specific employer at a time.
18. Making Service Available to the General Public
Independent contractors usually have the ability to make their services available to the general public. Employees usually serve only one employer at a time.
19. Right to Discharge
Independent contractors have contractual agreements that guarantee compensation for the contract period, as long as they meet the contract's terms and conditions. The compensating entity's right or ability to discharge a person usually suggests an employer and employee relationship.
20. Right to Terminate
Independent contractors cannot be terminated at will. Any termination must comply with the contract's terms and conditions. On the other hand, employees can be terminated at will.
Form SS-8 - Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
If the employer is still uncertain as to a workers status after reading publications and reviewing the relationships above, it can complete Form SS-8 and ask for the IRS to provide a finding on the status.
A mistake in classifying an employee can be extremely costly to both the employer and the employee. Care to properly classify workers must be taken in advance.