Is Your "Independent Contractor" Really Independent...?

Oct 26, 2021

What You Assume Could Land You In Hot Water

Stay On The Right Side Of The Independent Contractor Regulations

$227,000,000.00. What would happen to you or your business if you had to pay out a $227 million lawsuit?

My guess is it would crush, cripple, and likely bankrupt you. Well, that was a lawsuit FedEx settled because they misclassified what are commonly known as Independent Contractors, frequently referred to as 1099's here in the US.

Many entrepreneurs, coaches, consultants, and business owners use Independent Contractors and do so without any thought or consideration of doing it the right way.

This discussion is not meant to provide any legal advice but rather to present thought-provoking points to consider so you can pocket that $227 million and not pay it out.

What Does The IRS Say?

According to Investopedia, an Independent Contractor isself-employed person or entity contracted to perform work for—or provide services to—another entity as a nonemployee. As a result, independent contractors must pay their own Social Security and Medicare taxes.

The IRS defines it as:

People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.(The highlight and underline is my work and not from the IRS definition.)

The last sentence really speaks to what lies at the heart of numerous lawsuits and case law affecting Independent Contractors. Surprise, surprise, it comes down to control and per the IRS, control of the work and not what will be done or how it will be done.

This means if you hire a graphic artist to create artwork for your business, you can have input and control over the final design. For example, color, size, images etc. What you cannot do is require it be created in Photoshop, they have to work 9-5 to create it or even it must be done on a Mac vs a PC.

Where I cringe is when I see coaches, consultants, marketers etc hiring sales staff to sell high ticket coaching or consultative products and then exercise too much control over the work being done.

I typically see mandatory scripts, inflexible hours and other items with too much minutae. These are often red flags and should be considered seriously before being implemented. In fact, I would advise clients, businesses etc to seek out an employment attorney to review the details. I always provide my years of HR experience best practices and practical knowledge but some topics, independent contractors included, require a higher authority.

What Are Independent Contractor Details?

Fortunately, the IRS provides a great deal of information and resources on their website. According to the Common Law Rules, facts that provide evidence of the degree of control and independence fall into three categories:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Let's dig into these 1 at a time.

Behavioral actually has 4 categories which drive the answer:

  • Type of instructions given
  • Degree of instruction
  • Evaluation systems
  • Training

Type of Instructions Given: An employee is generally subject to the business’s 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 when performing the work.

Degrees of Instruction: Degree of Instruction means that the more detailed the instructions, the more control the business exercises over the worker. More detailed instructions indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.

Evaluation Systems: If an evaluation system measures the details of how the work is performed, then these factors would point to an employee. If the evaluation system measures just the end result, then this can point to either an independent contractor or an employee.

Training: If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee. Periodic or on-going training about procedures and methods is even stronger evidence of an employer-employee relationship. However, independent contractors ordinarily use their own methods.

The financial control factors fall into the categories of:

  • Significant investment
  • Unreimbursed expenses
  • Opportunity for profit or loss
  • Services available to the market
  • Method of payment

Significant Investment: An independent contractor often has a significant investment in the equipment he or she uses in working for someone else. However, in many occupations, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, a significant investment is not necessary for independent contractor status as some types of work simply do not require large expenditures.

Type of relationship refers to facts that show how the worker and business perceive their relationship to each other.

The factors, for the type of relationship between two parties, generally fall into the categories of:

  • Written contracts
  • Employee benefits
  • Permanency of the relationship
  • Services provided as key activity of the business

Unreimbursed 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 the services that they perform for their business.

Opportunity For Profit or Loss: The opportunity to make a profit or loss is another important factor. If a worker has a significant investment in the tools and equipment used and if the worker has unreimbursed expenses, the worker has a greater opportunity to lose money (i.e., their expenses will exceed their income from the work). Having the possibility of incurring a loss indicates that the worker is an independent contractor.

Services Available To The 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.

Method of Payment: 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.

Type of relationship refers to facts that show how the worker and business perceive their relationship to each other.

The factors, for the type of relationship between two parties, generally fall into the categories of:

  • Written contracts
  • Employee benefits
  • Permanency of the relationship
  • Services provided as key activity of the business

Written Contracts: Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status. The IRS is not required to follow a contract stating that the worker is an independent contractor, responsible for paying his or her own self employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.

Employee Benefits: Employee benefits include things like insurance, pension plans, paid vacation, sick days, and disability insurance. Businesses generally do not grant these benefits to independent contractors. However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor.

Permanency of the Relationship: If you hire 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 the intent was to create an employer-employee relationship.

Services Provided As Key Activity Of The Business: If a worker provides services that are a key aspect of the business, it is more likely that the business 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.

See? There are so many nuances to the decision to engage and use Independent Contractors. As is common with any government agency, there is often conflicting information within the same info which is all the more reason to consult an attorney.

Info compiled from