An excerpt from another Personnel Notebook, "Independent Contractor or Employee? Who's In Control Here?"

Many organizations and government agencies take a deep interest in the issue of independent contractors (ICs). Beyond unions and the National Labor Relations Board (NLRB), the Social Security Administration wants the FICA paid on employees, federal unemployment agents want to see the FUTA paid, and then there's Workers' Compensation and state unemployment compensation agencies who are also standing in that line.

Although all these organizations have a stake in this issue, the real driver in all the current action is the Internal Revenue Service (IRS), and they are really cracking down!

The IRS has a legitimate concern. They know companies like Eastern don't have to pay federal taxes on ICs as they do on employees. They also know the taxes to be paid by the worker are not deducted from the earnings of ICs as they are with employees.

The result is that the IRS estimates that it loses $3.7 billion annually resulting from workers' "misclassifications." In addition, ICs who would be expected to file their taxes as independent businesses often underpay or avoid payment altogether of their taxes and beyond that, many continue to pay taxes annually instead of quarterly as ICs are required to do.

So in 1986, the IRS created the new Employment Tax Examination Program and targeted small businesses (of less than $3 million annual revenues) as the greatest violators. During the first year of operation, they ruled against 92% of all employers they examined on IC classifications. That program is still in full swing and has been gaining momentum.

WHY IS THIS SUCH A HOT ISSUE NOW?

There are many political opinions on this, however, basic demographic changes in the workforce certainly must be recognized as part of the problem.

As downsizing, rightsizing, re-engineering organizations, and early retirement reduces the size of so many companies' workforce, the government is losing taxpayers and gaining tax users, (i.e., unemployment claims, welfare usage, etc.). However, many of those former employees are also becoming self-employed.

The government, particularly the IRS, wants to reinterpret the regulations to bring more or most of the ICs back into the employee tax base. This could result in a total reinterpretation of what an employee is. But let us start by identifying what an IC is.

WHAT IS AN INDEPENDENT CONTRACTOR?

The most common myth on ICs today is that a company can cut out a segment of the work that they now hire employees to perform and contract it out to someone else. Often to the same workers who formerly performed the work. At its worst, the company calculates its total cost of wages, benefits, taxes and tools and then convinces an employee to start their own company to perform the work for about 80% of that predetermined cost. In many such cases the worker makes less than they made on wages and sometimes less than minimum wage. This is clearly not what employers in general nor the IRS wants.

An independent contractor is basically one who operates their own company providing goods or services to clients for fees. However, that broad generic description is too easy to manipulate. Therefore, the IRS has attempted to create a standard. The standard is basically a judgment call often based on appearances, gut feelings and sometimes prejudice.

The decisions made by the IRS depend primarily on whether the employer has the control over both what the worker does and how he/she does it. The greater the control seems to be, the more likely the worker will be classified as an employee.

More specifically, the IRS uses the following 20 "Common Law" rules as their guidelines. The preponderance of "yes" answers on the more significant questions is used as evidence of an employer/employee relationship.

1. Do you provide the worker with instructions on when, where and how work is performed?

2. Did you train the worker in order to have the job performed correctly?

3. Are the worker's services a vital part of your company's operations?

4. Is the person prevented from delegating work to others?

5. Is the worker prohibited from hiring, supervising and paying assistants?

6. Does the worker perform services for you on a regular and continuous basis?

7. Do you set the hours of service for the worker?

8. Does the person work full time for your company?

9. Does the worker perform duties on your company's premises?

10. Do you control the order and sequence of the work performed?

11. Do you require workers to submit oral or written reports?

12. Do you pay the worker by the hour, week or month?

13. Do you pay for the worker's business and travel expenses?

14. Do you furnish tools or equipment for the worker?

15. Does the worker lack a "significant investment" in tools, equipment and facilities?

16. Is the worker insulated from suffering a loss as a result of the activities performed for your company?

17. Does the worker perform services solely for your firm?

18. Does the worker not make services available to the general public?

19. Do you have the right to discharge the worker at will?

20. Can the worker end the relationship without incurring any liability?

Based on IRS Revenue Ruling 87-41.

Although much of this seems reasonable, like many federal laws it is too vague, too subjective, open to misinterpretation and the final decision is all too often politically or financially motivated. Companies clearly want something more concrete, simple and logical as a guideline for this enormously affecting decision.

The balance of this issue will cover:

How to appeal a decision by the IRS.

5 things you can do now.

1997 update.