Classifying Service Providers as Employees or Independent Contractors

Question:        One of my employees is leaving the company but will continue to render services for our business. Is there a problem if I treat the worker as an independent contractor?

Answer:          You raise a common question faced by many business owners who engage non-employees to perform services. As you might suspect, there is no one factor that determines whether a worker is an employee or an independent contractor. Rather, there is a series of factors that must be considered to determine a worker’s status. The overriding consideration is whether the service recipient holds the right to direct not just the work to be done, but the manner in which the work is to be performed by the service provider. Where the requisite control by the service recipient exists, the worker is treated as an employee. In the absence of such control, the worker can be treated as an independent contractor.

Many years ago, the IRS enumerated various factors to be considered in distinguishing between an employee and an independent contractor. Still valid today, some of the relevant factors are the following:

  1. If the service recipient provides training to the service provider, the service provider is more likely to be classified as an employee. A service provider who does not receive training from the service recipient is more likely to be treated as an independent contractor.
  2. Where the service provider is required to personally render the services and cannot delegate the responsibility of performing services to others, an employer/employee relationship is more likely to exist. A service provider who can hire his/her own employees is more likely to be treated as an independent contractor.
  3. If the service recipient specifies the hours and times when the service provider is required to perform the services, an employment relationship is more likely to be found. A service provider who is free to set his/her own schedule will more likely be treated as an independent contractor.
  4. A service provider who provides regular reports to the service recipient as to the specific tasks performed and the manner in which the tasks are performed is more likely to be classified as an employee. The service provider who simply advises the service recipient of the progress of the work but not the manner in which the work is performed can more readily be treated as an independent contractor.
  5. If the service recipient provides tools or other equipment to the service provider, the worker is more likely to be classified as an employee. The service provider who utilizes his/her own equipment and tools in rendering the services is more likely to be treated as an independent contractor.
  6. If the service provider is allowed to and in fact renders services for more than one person or business, there is a greater likelihood that the service provider will be treated as an independent contractor than the service provider who is only permitted to render services for the service recipient.
  7. The service provider who can terminate the working relationship at any time is more likely to be treated as an employee than a service provider who must complete specific tasks for the service recipient before the working relationship can end.

The consequences of worker misclassification are significant, particularly where workers classified as independent contractors are determined to be employees. Employers are obligated to withhold from an employee’s wages and pay to the government Federal and State income and payroll taxes and must match the employee’s share of the payroll taxes paid.  Employees are also entitled to participate in an employer’s 401(k) and retirement plans, health insurance plans and other employer-sponsored plans. Where the service recipient is misclassified, the employer is responsible for unpaid taxes, interest and penalties.

Before deciding on your worker’s status, you should take the time to carefully analyze the working relationship and whether the service provider can justifiably be treated as an independent contractor. Where the factors suggest that the service provider is an independent contractor, an agreement should be prepared documenting the worker’s status and the various factors that support independent contractor treatment. Careful planning in this regard can avoid significant tax consequences.

The Tax Corner addresses various tax, estate, asset protection, and other business matters. Should you have any questions regarding the subject matter or if you have questions, you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.

Related Articles

Illinois and Chicago Overhaul Paid Leave Laws in 2024

Illinois and Chicago Overhaul Paid Leave Laws in 2024

In 2024, the employment landscape in Illinois, particularly in Chicago, will undergo a significant transformation with the implementation of two pivotal laws governing paid leave for workers. The Illinois Paid Leave for All Workers Act (the “Act”) introduces a comprehensive state-wide standard for paid leave, ensuring a minimum of forty hours annually of paid leave—which can be used for any reason—for all employees.