20 Questions: Independent Contractor or Employee?

What's at stake for your HOA?

Big Dollars — e.g. employment taxes and withholding, fringe benefits, workers compensation, and various federal and state laws affecting employees. Every HOA - condominiums, planned developments, town homes - employs a vast number of contractors. Some are hired by the HOA manager with little oversight from the board. But employment mistakes can be costly, and HOA board members should know the rules that distinguish between independent contractors and employees.

Clear answers are hard to find. The tax rules are a confusing patchwork of:

  1. Common Law
  2. Code‑based "statutory employees"
  3. Statutory independent contractor rules.

We must deal with rules set forth by:

  1. Internal Revenue Service ‑ Federal
  2. Employment Development Department ‑ State
  3. Workers Compensation rules as defined by the State of California.

Consequences of Employee Misclassification

Employee vs. Independent Contractor is the Most Contentious Tax Issue Around

The Internal Revenue Service is prevented from issuing regulations and rulings dealing with virtually all employment tax status issues except in cases of private letter rulings or technical advice memoranda.

Common Law Employees

Principles developed by courts rather than carried in the Code. Employer has right to control and direct the worker regarding the job he is to do and how he is to do it. Employer doesn't actually have to direct or control; it's enough if he has the right to do so.

By contrast, a worker who is subject to the control and direction by another only as to the result of his work, and not as to the means is an independent contractor not an employee.

Relationship Depends Upon All Facts and Circumstances in Each Case

Written agreement is helpful in establishing parties' intent to create a non‑employee relationship. However a contractual designation by itself doesn't conclusively establish a worker's status as employee or independent contractor.

Community associations should be very careful. If a person who is performing services covered by the State Contractor's Licensing Board does not have a license, he is an employee! A holding by the National Labor Relations Board is not binding on the Internal Revenue Service for tax purposes. An employer who is entitled to safe harbor protection under Section 530 may continue treating him as a non‑employee even if he would be an employee under common law rules.

Abbreviations Used in this Article

IRC: Internal Revenue Code

TREAS. REG.: Treasury Regulation

REV. RUL.: Revenue Ruling

C.B.: Cumulative Bulletin

What Factors Establish an Employee-Employer (EE/ER) Relationship?

For this test, twenty factors or elements have been identified as indicating whether sufficient control is present to establish an employee-employer (EE/ER) relationship. These factors are based upon an examination of cases and rulings made in the past regarding the EE/ER relationship. The degree of importance of each factor varies, depending on the occupation and the factual context in which the services are performed. The twenty factors are:

1. Instructions 

If a worker is required to comply with instructions concerning when, where, and how he or she is to complete the work, that individual is generally an EE. This factor is considered to be present if the person for whom the services are performed has the right to require compliance, however, the right does not need to exercised. (Rev. Rul. 68‑598, 1968‑2 C.B. 464 & Rev. Rul 66‑381, 1966‑2 C.B. 449.)

2. Training 

Training of the worker, regardless of the method (i.e. on the job, by correspondence, required attendance at meetings), indicates that an individual is expected to perform his/her work in a particular method. This is an indicator that the worker is being controlled and thus, is an EE. (Rev. Rul. 70‑630, 1970‑2 C.B. 229.)

3. Integration 

In applying the integration test, the scope and function of the business must first be determined and then, whether the services of the individual workers are merged into it. When the success or continuation of a business depends to a large extent upon the performance of certain services, the workers who perform those services must, of necessity, be subject to a certain amount of control by the owner of the business and therefore is considered to be an EE. (U.S. v. Silk, 331 U.S.704 [1947], 1947‑2 C. B. 167.)

4. Services Rendered Personally 

If the services must be rendered personally, presumably the business for whom the services are performed is interested in the methods used to accomplish the work as well as in the results. It is interested in not only the result, but also the worker. This is an indication that the worker is an EE. (Rev. Rul. 55‑695, 1955‑2 C.B. 410.)

5. Hiring, Supervising, and Paying Assistants 

If the business for whom the services are performed, hire, supervise and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises and pays the other assistants pursuant to a contract under which that worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status. (Rev. Rul 63‑115, 1963‑1 C.B. 178 & Rev. Rul 55‑593, 1955‑2 C.B. 610, Rev. Rul. 70‑440, 1970 C.B. 610.)

6. Continuing Relationship 

A continuing relationship between the worker and the business for whom the services are performed indicates that an EE/ER relationship exists. Continuing services may include work performed at frequently recurring, though somewhat irregular, intervals either on call or whenever the work is available. The relationship can be considered permanent even if the services are part‑time, seasonal, or of short duration. (U.S. v. Silk.)

7. Set Hours of Work

The establishment of set hours of work by the business for whom the services are performed is a factor indicating control and therefore an EE/ER relationship exists. This condition bars the worker from being master of his/her own time, which is the right of the independent contractor. (Rev. Rul. 73‑591, 1973‑2 C.B. 337.)

8. Full Time Required 

If a worker must devote substantially full time to a business, the owners of that business have control over the amount of time the worker spends working and therefore restricts the worker from doing other gainful work. An IC, on the other hand, is free to work when and for whom he/she chooses. Full time does not necessarily mean an 8‑hour day or a 5 or 6‑day week. Its meaning may vary with the intent of the parties involved, the nature of the occupation and the customs in the locality. Full‑time services may be required even though not specified in writing or orally. For example, to produce a required minimum volume of business may compel a person to devote all of his/her working time to that business. (Rev. Rul. 56‑694, 1956‑2. C.B. 694.)

9. Doing Work on Employer's Premises 

If the work is done on the business' premises, that factor suggests control of the worker, especially if the work could be done elsewhere. A person working in the employer's place of business is physically within the employer's direction and supervision. The use of desk space and telephone services provided by the business places the worker within the direction and supervision of that business. Work done off the premises indicates some freedom from control. However, this fact by itself does not create an independent contractor. Control over the place of work is indicated when the business for whom the services are performed has the right to compel the worker to travel a designated route, to canvas a territory within a certain time, or to work at specific places as required. (Rev. Rul. 56‑660, 1956‑2 C.B. 693 & Rev. Rul. 56‑694, 1956‑2 C.B. 694.)

10. Order of Services

An EVER relationship exists if the worker is not free to follow his/her own pattern of work, but must perform the services in an order specified by the business for whom the services are performed. Often, because of the nature of the work, the business either does not set the order or sets it infrequently. This does not mean that there is an independent contractor relationship, since as long as the business has the right to control, there is an employee/employer relationship. Such a right to direct the worker supersedes the preferences over his/her routine and plans. (Rev. Rul. 56‑694, 1956‑2 C.B. 694.)

11. Oral or Written Reports 

If a worker is required to submit oral or written reports to the business for whom the services are performed, this indicates that the worker is being compelled to account for his/her actions. This shows a desire to control and thus, an EE/ER relationship. (Rev. Rul 70‑309, 1970‑1 C.B. 199 & Rev. Rul. 68‑248, 1968‑1 C.B. 431.)

12. Payment by Hour, Week, Month

These methods of payment generally point to an EE/ER relationship, provided that the method of payment is not just a convenient way of paying a lump sum agreed upon as a cost of the job. Payment made by the job or on a straight commission generally indicates that the worker is an IC. (Rev. Rul. 74‑389, 1974‑2 C.B. 330.)

13. Payment of Business and/or Traveling Expenses 

When these expenses are paid by the business for whom the services are performed, the worker is generally considered to be an EE since the ER must retain the right to regulate and direct the worker's business activities in order to properly control expenses. Conversely, a worker who is paid on a job basis and who has to take care of all incidental expense is generally an independent contractor. Since he is accountable only to himself for his expenses, he is free to work according to his own methods and means. (Rev. Rul. 55‑144, 1955‑1 C.B. 483.)

14. Furnishing Tools and Materials 

The fact that the business for whom the services are performed furnishes the significant tools, materials, and other equipment shows the existence of an EVER relationship. Such a business can determine which tools the worker is to use and, to some extent, in what order they are to be used. However, in some occupation (i.e. construction), the workers customarily provide their own hand tools. This does not indicate an independent contractor status. (Rev. Rul. 71‑524, 1971‑2 C.B. 346.)

15. Significant Investment

If the worker has made no significant investment in facilities and/or equipment used in performing services for another, there is a dependency on the business for whom the services are performed and, therefore, an EE/ER relationship exists. In order for an investment to be considered to be significant, it must be "real", "essential", and "adequate". In order to be "real", the worker must have legal ownership and true equity in the property. An investment in equipment or premises not required to perform the services in question is not "essential". If the worker must rely appreciably on the facilities of others to perform the required services, his/her investment is not considered to be "adequate". Ownership of equipment or premises points toward an independent contractor status. However, if the owner (worker), as part of the agreement, surrenders dominion over the equipment or premises and the right to decide how they shall be used by renting it to the business, "ownership" loses its significance. (Rev. Rul. 71‑524, 1971‑2 C.B. 346.)

16. Realization of Profit or Loss

A worker who can realize a profit or suffer a loss as a result of his/her efforts is generally an IC, but a worker who cannot is an EE. This implies the use of capital by the individual in an independent contractor status. Thus, the opportunity for higher earnings, such as from pay on a piecework basis or the possibility of gain or loss from a commission arrangement is not considered profit or loss. Whether a profit is realized or a loss suffered generally depends upon management decisions. That is, the one responsible can use his/her own ingenuity, initiative, and judgement in conducting his/her business. (Rev. Rul. 70‑309, 1970‑1 C.B. 199.)

17. Working for More than One Firm at a Time

Persons who work for a number of individuals or firms at the same time are generally IC's because they are usually free from control by any of the individuals or firms. It is possible, however, for a person to work for a number of businesses at the same time and still be an employee of each of them. (Rev. Rul. 70‑572, 1970‑2 C.B. 221.)

18. Making Services Available to the General Public 

The fact that a worker makes his/her services available to the general public on a regular and consistent basis indicates an IC relationship. An individual may hold his/her services out to the public in a number of ways: by hanging out a "shingle" in front of his home or business; by holding a business license; by being listed in business or telephone directories, or by advertising in the newspaper or trade journals. (Rev. Rul. 56‑660, 1956‑2 C.B. 693.)

19. Right to Discharge 

The right to discharge is a factor indicating that the worker is an EE and the person possessing the right is an ER. An IC, on the other hand, cannot be fired so long as he/she produces results that meet the contractual specifications. What it comes down to is that if the work done by an individual is substandard and the business fires him/her, there is an EE/ER relationship. If the business can sue the worker, there is an independent contractor relationship. (Rev. Ru175‑41, 1975‑1 C.B. 323.)

20. Right to Quit 

If the worker has the right to end his/her relationship with the business for whom services are performed at any time without incurring liability, that factor indicates an EE/ER relationship exists. (Rev. Rul 70‑309, 1970‑1 C.B. 199.)

Exempt or Nonexempt? Employee Classification, Overtime, and Tax Law

It is important to note that none of these factors of control needs to be exercised by the employer as long as he/she maintains the right to them, there is an employer employee relationship. No one of these factors is the deciding factor by itself. They are looked at as a whole and weight is given to each factor depending upon the industry and the work involved.

  • Industry Practice or Custom in the Area of the Parties
  • The Intent of the Parties
  • Whether Written, Signed Independent Contractor Agreements were Executed
  • Whether Employee-Type Benefits were Provided

Bob Castle is the principal at the accounting firm of Robert L. Castle, Certified Public Accountant, in Oakland, CA. He is a member of the ECHO Accountants Resource Panel.