Independent Contractor Rules of Thumb

  1. The institution's right of supervision and control over the worker is the critical issue. Many of the other factors are simply tools to uncover evidence of control (or the lack of it). Always focus your attention on the control factor.
  2. Start your analysis by determining whether the worker will be integrated into the institution's workforce and operations.
  1. If the worker is not integrated into the institution's operations and the right of control is not obviously apparent (no training, no work hours, no reports), you are reasonably safe as long as the relationship is short-term and the independent contractor has other customers.
  2. If the worker is integrated into the institution's operations, the institution is at risk (because control is likely to be inferred from integration) unless several factors point strongly in the direction of independent contractor status. Look for evidence the worker is engaged in a distinct business or occupation requiring specialized skill. Scrupulously avoid any overt expressions of control.
  1. Be aware that the status of a particular worker usually lies somewhere along a continuum. Your goal is to avoid obvious misclassifications and narrow the area of uncertainty.
  2. The decision to hire an independent contractor represents a calculated business risk. Assess the risk of misclassification, including the dollar amount of payment and duration of relationship, probability that worker will voluntarily pay income tax withholding and social security self-employment tax, risk of liability for workplace injury, etc.

Internal Revenue Service Safe Harbor Exception

Even if the IRS determines that a worker is an employee, it will not assess back employment taxes if the employer qualifies for the so-called "safe harbor exception" (Revenue Act of 1978, Section 530).

The IRS safe harbor does not apply to state taxes and withholding, worker's compensation, etc. Nor does it apply to skilled technical services personnel performing services for the institution’s clients.

Employers should determine in advance whether a prospective independent contractor relationship may qualify for safe harbor protection. It is possible (but not recommended) to obtain an advance opinion from the IRS.

To qualify for the safe harbor, the following three requirements must be satisfied:

  1. The institution has never treated the independent contractor as an employee, and has filed Form 1099's for him/her in a timely manner.
  2. The institution has consistently treated workers in a substantially similar position as independent contractors.
  3. The institution has a reasonable basis for treating the worker as an independent contractor. Reasonable basis means:
  • Reliance on court decisions, published IRS rulings, and certain other kinds of technical advice; or
  • In a past IRS audit, the institution was not assessed employment taxes for treating workers doing a similar type of work as independent contractors; or
  • It is a recognized, long-standing practice for a large segment of the industry to treat certain types of workers as independent contractors.

Legal Tests of Independent Contractor Status

Common Law Test

  1. A worker is an employee if the institution has the right to control the manner and means of accomplishing the result desired.
  2. An employee is paid for his/her time and bears no risk of wage loss if the employer’s product is unprofitable. An independent contractor has the opportunity to profit from the project and the risk of loss, depending on the worker's managerial skill.
  3. An employee is not required to invest in the employer’s business. An independent contractor makes some investment in tools, equipment, supplies, and facilities appropriate for his/her business.
  4. An employee may receive training. An independent contractor has the skills necessary to perform the task without additional training.
  5. An employee enjoys a continuing relationship with the employer. An independent contractor generally works on one project and moves on, accepting additional projects when and if available.
  6. An employee provides services that are essential to the employer’s business and incorporated into its products and services.

Internal Revenue Service Twenty Factor Test

Factor 1 No instructions

Contractors are not required to follow, nor are they furnished with instructions to accomplish a job. They can be provided job specifications by the hiring firm.

Factor 2 No training

Contractors typically do not receive training by the hiring firm. They use their own methods to accomplish the work.

Factor 3 Services don't have to be rendered personally

Contractors are hired to provide a result and usually have the right to hire others to do the actual work.

Factor 4 Work not essential to the hiring firm

A company's success or continuation should not depend on the service of outside contractor. An example violating this would be a law firm which called their lawyers independent contractors.

Factor 5 Set own work hours

Contractors set their own work hours.

Factor 6 Not a continuing relationship

Usually contractors don't have a continuing relationship with a hiring company. The relationship can be frequent, but it must be at irregular intervals, on call or whenever work is available. Warning: Part-time, seasonal or short-duration relationships have nothing to do with independent contractor status.

Factor 7 Control their own assistants

Contractors shouldn't hire, supervise, or pay assistants at the direction of the hiring company. If assistants are hired, it should be at the contractor's sole discretion.

Factor 8 Time to pursue other work

Contractors should have enough time available to pursue other gainful work.

Factor 9 Decide on job location

Contractors control where they work. If they work on the premises of the hiring company, it is not under that company’s direction or supervision.

Factor 10 Order of work set

Contractors determine the order and sequence they will perform their work.

Factor 11 No interim reports

Contractors are hired for the final result and therefore should not be asked for progress or interim reports.

Factor 12 Paid by job

Contractors are paid by the job, not by time. Payment by the job can include periodic payments based on a percentage of job completed. Payment can be based on the number of hours needed to do the job times a fixed hourly rate. However, this should be determined before the job begins.

Factor 13 Work for multiple firms

Contractors often work for more than one firm at a time.

Factor 14 Pay business expenses

Contractors generally are responsible for their incidental expenses.

Factor 15 Have own tools

Usually contractors furnish their own tools. Some hiring firms have leased equipment to their independent contractors-so they could show the contractor had their own tools and an investment in their business (see # 16). This strategy won’t work if the lease is for a nominal amount or can be canceled by the hiring firm at will. In short, the lease must be equivalent to what an independent business person could have obtained in the open market. For more information, contact a labor attorney.

Factor 16 Significant investment in their business

Contractors should be able to perform their services without the hiring company’s facilities (equipment, office furniture, machinery, etc.). The contractor's investment in his/her trade must be real, essential and adequate (see #15).

Factor 17 Offer services to general public

Contractors make their services available to the general public by one or more of the following:

  • Having an office and assistants
  • having business signs;
  • having a business license;
  • listing their services in a business directory;
  • advertising their services.
Factor 18 Can make entrepreneurial profit or loss

Contractors should be able to make a profit or a loss. Employees can't suffer a loss. Five circumstances show that profit or loss is possible:

  • If the contractor hires, directs and pays assistants;
  • if the contractor has his/her own office, equipment, materials or facilities;
  • if the contractor has continuing and reoccurring liabilities;
  • if the contractor has agreed to perform specific jobs for prices agreed upon in advance;
  • if the contractor's services affect his/her own business reputation.
Factor 19 Can't be fired at will

Contractors can't be fired so long as they produce a result which meets the contract specifications.

Factor 20 No compensation for non-completion

Contractors are responsible for the satisfactory completion of a job or they may be legally obligated to compensate the hiring firm for failure to complete.

Economic Realities Test

A worker is an employee if he/she is a member of a class of workers intended to be protected by a law designed to protect or benefit employees.

Smell Test

Takes into account totality of circumstances. Designed to foreclose efforts to artificially structure a relationship to circumvent the applicable criteria.

Helpful Tips

  • Watch out for independent contractors who are former employees performing the same job as before.
  • Watch out for independent contractors who are doing the same job as employees.
  • Don't rely on industry practice to protect your institution.
  • If you think your independent contractor will never claim to be an employee, think again!
  • Your PI's working relationship with an independent contractor should be based on the terms and conditions of their contract. Don’t use the human relations department or the institution's personnel policies to resolve problems. If you have a problem, modify the contract.
  • Don't invite independent contractors to employee functions.
  • Try to minimize independent contractors' contact with funding agencies, etc.
  • Keep independent contractor records in vendor files, not employee files. Require invoices.
  • Work with your institution's legal office to develop policies and procedures.