Dr. Adrienne B. Haynes, Esq.
Contributor

One of the most frequent questions we get asked at SEED Law from growing companies is how to distinguish and document the relationships between independent contractors and employees.

The distinctions between the employee and independent contractor relationship are drawn from common law tests developed over the years from case law. In 1987, the IRS reviewed the rulings and established the “20 Factors Test,” intended for use as a sliding scale consideration tool. In combination with the industry, facts, and other considerations, the listed factors made it easier to determine if the appropriate relationship was more of an employee or independent contractor. According to the IRS, “Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.” 

The IRS can and does consider factors beyond the twenty factors outlined, and how each is  considered and weighed is determined on a case by case basis. To make this determination more streamlined for owners and team members, the IRS developed a three-factor control test. This takes into account behavioral control, financial control, and the type of relationship of the parties.

Behavioral control: The behavioral control factor looks at the right to direct or control how the worker carries out the assigned work. In making this determination, the IRS takes into account the following factors:

  • Type of instructions given
  • Degree of instruction
  • Evaluation systems
  • Training

Financial control: The financial control factor takes into account the involvement of a company on the economic aspects of the assigned work. In making this determination, the IRS takes into account the following factors:

  • Significant investment
  • Unreimbursed expenses
  • Opportunity for profit or loss
  • Services available to the market
  • Method of payment

Type of relationship: This final factor looks at how the parties in question perceive their relationship, including how they’ve documented their agreement and additional benefits conferred. To make this determination, the following factors are weighed:

  • Written contracts
  • Employee benefits
  • Permanency of the relationship
  • Services provided as key activity of the business

After you determine the most appropriate way to categorize the position or team member, be sure to document the relationship well to keep your HR department in compliance.

If the relationship is ever in question, the IRS will ask you to complete an SS-8 within a designated time frame and include any accompanying documentation. You’ll want to have a complete record in order to prepare a complete and accurate response. If it is found that an employee is misclassified as an independent contractor, the employer may be able to change the classification in advance if certain conditions are met. Otherwise, the liabilities can include back pay, social security payments, Medicare payments, worker’s compensation contributions, unemployment premiums, interest and penalties, and any associated attorney’s fees.

Making this determination may seem simple, but it should be weighed in the hiring considerations of each position and monitored over the course of the relationship. This article is only an overview of employment law considerations and is not intended to cover every legal right or obligation, consideration, exception, or restriction. These strategies and decisions are complex and should be well researched and discussed with a legal professional before being made.

The next business law workshop, Startup Law- Preparing to Open Your Business, will be hosted on Wednesday, June 10th from 12-1 pm on Zoom. Almost all business decisions have legal consequences. Understanding where the laws apply to your business operations can help you make confident decisions, protect your rights, minimize risk and save money. This workshop will offer an overview of business law hot topics, including choice of entity, managing contractual obligations, and compliance. To register for free and see the full list of virtual and in person events, please visit https://showmenetwork.org/calendar/

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Thanks for reading!

My name is Dr. Adrienne B. Haynes and I’m an entrepreneur and attorney based here in Kansas City. My law firm, SEED Law, has been partnering with business owners across the Northeast and the city for almost 11 years. I loved living in the Northeast and I was fortunate to serve as an Entrepreneur in Residence for the Kauffman Foundation in 2017. Together with a dedicated group of Northeast residents and leaders, we explored a community designed innovation district pilot program. I was able to present this work during a TEDxUMKC Talk on Community Innovation Design in 2020.

Over the next few weeks, I’ll be contributing articles and resources on small business and estate planning legal considerations. If you have questions, please reach out directly at adrienne@seed.legal.