- New IRS Independent Contractor Test
- October 16, 2006 | Author: Lisa B. Petkun
- Law Firm: Pepper Hamilton LLP - Philadelphia Office
Historically, the IRS used what has become known as the “Twenty Factor” test to determine whether a worker is an independent contractor or an employee. In January, 2006, in response to comments by Congress and representatives of labor and business, the IRS attempted to simplify and refine the test. The revised test is founding the 2006 Edition of IRS Publication 15-A. It consolidated the 20 factors into 11 main tests, and organized them into three main groups: behavioral control; financial control; and the type of relationship between the two parties.
Behavioral control covers facts that show whether the business has a right to direct and control how the work is done through instructions and/or training. Generally, an employee is subject to the business’ instructions regarding when, where and how to work, and is usually trained by the business to perform the task in a particular manner, whereas an independent contractor would not be subject to this kind of behavioral control.
Financial control focuses on whether the business has a right to control the business aspects of the worker’s job. Factors examined are: 1) the extent to which the worker has unreimbursed business expenses; 2) the extent of the worker’s investment; 3) the extent to which the worker makes his or her services available to the relevant market; 4) how the business pays the worker; and 5) the extent to which the worker can realize a profit or loss. For example, independent contractors are more likely to have unreimbursed expenses, be available to work for others in the relevant market, and make a profit or loss.
The last group is the type of relationship that exists between the worker and the business. Are there written contracts describing the relationship the parties intended to create? Does the business provide the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay? Is there an expectation that the relationship will continue indefinitely rather than for a specific project or period? The last factor in this group is the extent to which services performed by the worker are a key aspect of the regular business of the company. An employee is more likely to have a permanent relationship with a company than is an independent contactor, and an employee is more likely to provide services that are a key aspect of the business.
Examination of the above factors in the working relationship determines whether a worker is an employee of the business or an independent contractor. A business or a worker who would like the IRS to determine the worker’s status can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Form SS-8 requests detailed information which reflects the factors discussed above. Upon receipt of this form, the IRS will seek additional information from all parties who would be affected by the determination by sending those parties a blank Form SS-8 for completion. The matter would then be assigned to a technician who would review the facts, apply the law, and render a decision by sending a formal determination letter to the requestor and a copy to the affected worker (or class of workers). The decision is binding on the affected worker (or class of workers), the business, and the IRS.
Even though the IRS has now organized the tests differently, applying the revised factors to specific individuals performing services is no easier than applying the Twenty Factor test. Each determination requires careful attention to the facts and the agreements. The only method to obtain assurance is to file Form SS-8.