The determination as to whether a person is an employee or independent contractor is extremely important to both the employer and other person. The determination has substantial tax ramifications for both parties and may determine who has the risk of loss in many situations.

Complicating the situation is the fact that it is possible to be considered an employee by one governmental body and an independent contractor by another.

Any one or more of the following may determine whether a person is an employee or independent contractor:

The test used for federal tax purposes may differ from the test used in a workers’ compensation case or a sexual harassment case.

Due to the high risk of making a misclassification error, and the negative consequences resulting from such a mistake, we urge both employers and those performing work to be conservative in their decision making. An experienced employment attorney with our firm can assist you with all aspects of employment law.

Some of the differences between employees and independent contractors follows:

Element or Factor	Employee	Independent Contractor
Employer must make contributions for Social Security taxes	Yes	No
Employer must make contributions for Medicare taxes	Yes	No
Employer must withhold all applicable taxes including state and federal income taxes	Yes	No
File Form 1099 – MISC with IRS if you pay the person $600 or more	No	Yes
Pay for Workers’ Compensation Insurance covering the person working	Yes	No
Pay into the Unemployment Insurance Fund	Yes	No
Worker is eligible for job benefits such as paid vacation, sick leave, holiday pay, and stock options	Yes	No
Worker is eligible for overtime pay	Yes	No
Employer has the right to control how the worker performs the specific task for which hired	Yes	No
Employer has the right to direct or control how the business aspects of the worker’s activities are conducted	Yes	No

It is easy to understand why employers tend to misclassify works as employees when they are actually independent contractors.

The following information was taken directly

from the Internal Revenue Service:

1. Who Are Employees?

Before you can know how to treat payments that you make to workers for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be:

• An independent contractor,



• A common – law employee,



• A statutory employee, or



• A statutory nonemployee.

This discussion explains these four categories. A later discussion, Employee or Independent Contractor? (section 2), points out the differences between an independent contractor and an employee.

Independent Contractors

People such as lawyers, contractors and subcontractors who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees. However, whether such people are employees or independent contractors depends on the facts in each case. The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Common – Law Employees

Under common – law rules, anyone who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

If you have an employer – employee relationship, it makes no difference how it is labeled. The substance of the relationship, not the label, governs the worker’s status. It does not matter whether the individual is employed full time or part time.

For employment tax purposes, no distinction is made between classes of employees. Superintendents, managers, and other supervisory personnel are all employees. An officer of a corporation is generally an employee; however, an officer who performs no services or only minor services, and neither receives nor is entitled to receive any pay, is not considered an employee. A director of a corporation is not an employee with respect to services performed as a director.

You generally have to withhold and pay income, Social Security, and Medicare taxes on wages that you pay to common – law employees. However, the wages of certain employees may be exempt from one or more of these taxes.

Leased employees. Under certain circumstances, a firm furnishing workers to other firms is the employer of those workers for employment tax purposes. For example, a temporary staffing service may provide the services of secretaries, nurses, and other similarly trained workers to its clients on a temporary basis.

The staffing service enters into contracts with the clients under which the clients specify the services to be provided and a fee is paid to the staffing service for each individual furnished. The staffing service has the right to control and direct the worker’s services for the client, including the right to discharge or reassign the worker. The staffing service hires the workers, controls the payment of their wages, provides them with unemployment insurance and other benefits, and is the employer for employment tax purposes.

Statutory Employees

If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute, "statutory employees," for certain employment tax purposes. See an experienced employment attorney for a further explanation.

Statutory Nonemployees

There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Direct sellers and licensed real estate agents are treated as self – employed for all federal tax purposes, including income and employment taxes, if:

• Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked and



• Their services are performed under a written contract providing that they will not be treated as employees for federal tax purposes.

Direct sellers. Direct sellers include persons falling within any of the following three groups.

Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers. Such activities include providing motivation and encouragement; imparting skills, knowledge, or experience; and recruiting.

Licensed real estate agents. This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.

Companion sitters. Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled. A person engaged in the trade or business of putting the sitters in touch with individuals who wish to employ them (that is, a companion sitting placement service) will not be treated as the employer of the sitters if that person does not receive or pay the salary or wages of the sitters and is compensated by the sitters or the persons who employ them on a fee basis. Companion sitters who are not employees of a companion sitting placement service are generally treated as self – employed for all federal tax purposes.

Misclassification of Employees

Consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.

2. Employee or Independent Contractor?

An employer must generally withhold federal income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.

Common – Law Rules

To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. In any employee – independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.

Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties. These facts are discussed below.

Behavioral control. Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:

Instructions that the business gives to the worker. An employee is generally subject to the business’ instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work.

When and where to do the work. What tools or equipment to use. What workers to hire or to assist with the work. Where to purchase supplies and services. What work must be performed by a specified individual. What order or sequence to follow.

The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up the right.

Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

Financial control. Facts that show whether the business has a right to control the business aspects of the worker’s job include:

The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with these services that they perform for their business.

The extent of the worker’s investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.

The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.

How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.

The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.

Type of relationship. Facts that show the parties’ type of relationship include:

• Written contracts describing the relationship the parties intended to create.
  
  

• Whether or not the business provides the worker with employee – type benefits, such as insurance, a pension plan, vacation pay, or sick pay.
  
  

• The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer – employee relationship.
  
  

• The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work. This would indicate an employer – employee relationship.

The following information was taken from

the California Department of Industrial Relations:

Not all workers are employees as they may be volunteers or independent contractors. Employers oftentimes improperly classify their employees as independent contractors so that they, the employer, do not have to pay payroll taxes, the minimum wage or overtime, comply with other wage and hour law requirements such as providing meal periods and rest breaks, or reimburse their workers for business expenses incurred in performing their jobs. Additionally, employers do not have to cover independent contractors under workers’ compensation insurance, and are not liable for payments under unemployment insurance, disability insurance, or social security.

The state agencies most involved with the determination of independent contractor status are the Employment Development Department (EDD), which is concerned with employment-related taxes, and the Division of Labor Standards Enforcement (DLSE), which is concerned with whether the wage, hour and workers’ compensation insurance laws apply. There are other agencies, such as the Franchise Tax Board (FTB), Division of Workers’ Compensation (DWC), and the Contractors State Licensing Board (CSLB), that also have regulations or requirements concerning independent contractors. Since different laws may be involved in a particular situation such as a termination of employment, it is possible that the same individual may be considered an employee for purposes of one law and an independent contractor under another law. Because the potential liabilities and penalties are significant if an individual is treated as an independent contractor and later found to be an employee, each working relationship should be thoroughly researched and analyzed before it is established.

There is a rebuttable presumption that where a worker performs services that require a license pursuant to Business and Professions Code, or performs services for a person who is required to obtain such a license, the worker is an employee and not an independent contractor.