One of the mistakes business owners are likely to make is failing to have the appropriate worker’s status. The two choices in this regard are an ‘employee’ or an ‘independent contractor.’ Both of them have their specific characteristics that can affect a business significantly. Thus, both the employer and worker need to be well aware of this status beforehand. Fortunately, there is a list of criteria known as the IRS 20 factor test in determining this.
There are certain strict IRS (Internal Revenue Service) rules in regards to the classification of ICs. Erroneous classification of an employee as an independent contractor, or vice versa, could lead to disastrous consequences for both the worker and employer.
The IRS 20 factors help to ascertain whether a worker is classified as an employee or independent contractor. This article aims to explain all about IRS 20 factors and the conclusions you can draw from this.
Independent Contractor vs. Employee
The IRS 20 factors revolve around three different principles – behavioral control, financial control, and the parties’ relationship. Admittedly, these factors can be somewhat vague to define. Thus, you can only try to answer in the most accurate way possible. Also, keep in mind that the answer can still be nebulous.
The IRS 20 Factors Test
Although the IRS no longer uses this particular test to determine a worker’s status, the IRS 20 factors are still helpful to analyze whether the worker is an employee or an independent contractor.
1. Instructions or Direction of the Worker
An employee is usually a worker who must follow instructions regarding when, where, and how to work. These instructions could be written procedures or manuals that show how to get the required results.
2. Amount of Training
The more training your business provides to the worker, the more chances there are of him or her being an employee. On the other hand, independent contractors are expected to know how to do their work and should not need training from their employers.
3. Degree of Business Integration
If a worker’s services are integrated into business operations or notably affect the business’ success, then you can classify them as an employee.
4. Extent of Personal Services
Generally, independent contractors are free to outsource their work. However, employees are supposed to perform the work by themselves.
5. Control of Assistants
If a business hires, supervises, and pays the assistants of a worker, it indicates a potential employment relationship. On the other hand, independent contractors usually retain control over hiring, supervising, and paying assistants.
6. Continuous Relationship
An employer-employee relationship generally features a continuous relationship between a person and the person for whom they perform services.
7. Control Over Their Schedule
Workers for whom the employer dictates certain set hours of work are usually employees. On the other hand, independent contractors have the freedom to set work hours at their convenience.
8. Demand for Full-Time Work
Normally, an employee works full time for their employer. On the other hand, an independent contractor can freely work when and for whom they choose.
9. On-Site Work
Necessitating someone to work on the business premises indicates a probable employment relationship. This especially holds true if the work in question can be conveniently done elsewhere.
10. Sequence of Work
Generally, the sequence of work is an employee’s order of performance of services or could be set by the employer.
11. Reports
If a business asks workers to bring in regular reports regarding their project’s status, it indicates a possible employment relationship.
12. Method of Payment
Employment relationships generally feature hourly, weekly, or monthly payments. On the other hand, payment on project completion or commission generally indicates an independent contractor relationship.
13. Expenses
Independent contractors usually have to bear travel and business expenses on their own. However, employees generally are given some amount of compensation in this regard by their employer.
14. Use of tools and material
Employees usually use the business’s equipment, tools, and material.
15. Share in Profit or Loss
Independent contractors do not have any share in profit or loss. However, employees could possibly be part of profit-sharing plans.
16. Level of Investment
Independent contractors usually invest in and maintain their work facilities themselves. However, employees typically depend on their employer to give them work facilities.
17. Ability to Work Elsewhere
An independent contractor could perform services for multiple unrelated companies simultaneously.
18. Availability to the General Public
An independent contractor can regularly make their services available to the general public.
19. Control Over Discharge
The employer has the right to fire an employee.
20. Right to Terminate
An employee can leave his or her job anytime without incurring any liability. However, an independent contractor cannot do the same unless it’s stated in the contract.
Which Form Should You File?
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Form 1099 is used to report payments to an independent contractor. On the other hand, you can use the W-2 form to distribute wages to an employee. Using the IRS 20 factors, a worker must properly ascertain whether you can classify them as an employee or independent contractor. After that, they must fill up the appropriate form.
Why Is It Important to File a 1099 Form?
Independent contractors, despite their quality services, can also make things complicated during tax season. Taxpayers use 109 forms like independent contractors and freelancers to provide information to the IRS. It includes all about their yearly income sources apart from their regular salary. This includes non-employee compensation and federal and state income taxes withheld. It also covers medical bills and healthcare payments.
You must give the 1099 form to any independent contractor paid over $600 in business payments for their work. The IRS considers this an “information return” and uses it to collect the right amount of taxes. It also helps them to combat tax evasion. Failing to do so can invite an audit from the IRS. Thus, it is important to consider the IRS 20 factors and avoid misclassification as soon as possible.
