Independent Contractor Control Tests
The California Common-Law Right to Control Test: California courts and administrative agencies generally apply common-law principles to determine independent contractor status. The most important factor is whether the business had the right to direct and control the manner and means of performing the work. If your company controls the details and the worker does not have "meaningful discretion" in how he/she completes the work, it is likely that the worker will found to be an employee and not an independent contractor. If you merely "oversee the results" but not the means of accomplishing the results, courts will generally uphold the independent contractor status.
In one case involving a district manager for an insurance company, the court held that a company can set objectives and minimum standards for an independent contractor without losing independent contractor status. Although the independent contractor agreement asked the worker to meet minimum performance standards, the agreement did not specify how she should meet these standards. It also said she should develop plans to exceed these standards. According to the court, the company "did not have sufficient control over the details" to render her an employee. The court called it a "classic example of the setting of results while leaving the means to [the worker]."
In another case, an accountant worked for a tax preparation service as independent contractor for several years before the employer and the independent contractor learned that the accountant should actually be an employee. The two parties agreed to change the individual’s status at the beginning of the next calendar year, but the company sold just before the change. The new employer did not reclassify the accountant’s status. The accountant was required to attend staff meetings and fill out time sheets. The employer set the fee schedule for tax prep and collected fees. The accountant had no outside clients, was marketed to clients as an employee and was provided with business cards. The court of appeal found the plaintiff was an employee, and upheld the lower court’s penalty against the employer for failure to pay final wages in the time required by law.
Sometimes who has the right of control is readily apparent. If not, courts have listed additional factors that can show whether the right of control exists:
Other points to remember in determining if a worker is an employee or independent contractor:
When considering your independent contractor relationships you should:
Independent Contractor Ruling Gives Guidance: A California case provides employers with a good checklist on how to treat workers, such as salespeople, so the employer can maintain an independent contractor relationship. Arnold v. Mutual, details the factors under which insurance agents may properly be classified as independent contractors.
A salesperson filed a lawsuit against Mutual, alleging that she should have been classified as an employee, not an independent contractor.
The court of appeal applied the “right of control” test: Does the employer have the right to control the manner and means by which the individual performs his work? The Arnold court examined the evidence presented by Mutual and found that Mutual exercised little control over the plaintiff (or over the other agents) and that they were properly classified as independent contractors. The following factors, as a whole, were persuasive to the court:
Collective Bargaining Agreements May Impact Status: The right to control the work is still the most important factor in determining independent contractor or employee status, but courts must also consider other factors. Some of those other factors include if you provide benefits to the workers and the terms of a collective bargaining agreement (CBA) that’s in place.
In Arzate v. Bridge Terminal Transport, Inc., truck owners transporting cargo between ports and an employer’s customers brought suit against Bridge Terminal Transport, Inc., for failure to:
The truck drivers were members of the Teamsters Union and were subject to a CBA between Bridge Terminal and the Teamsters. According to the CBA, the truck drivers who brought this claim were classified as employee owner-operators who worked exclusively for Bridge Terminal. The drivers received W-2 wage and tax statements which indicated they were employees of the organization and they were eligible for organization’s health insurance plan. In Arzate v. Bridge Terminal Transport, Inc., the Court of Appeal ruled that the drivers were employees, not independent contractors, and returned the case to the lower court.
Defining Independent Contractor for Federal Tax Purposes: The IRS will determine if an employment relationship exists between a worker and employer, and if that relationship requires payment of federal employment taxes, including Social Security taxes, payment under the Federal Unemployment Tax Act, and withholding of worker-owed employment taxes.
Misclassification of bona fide employees as independent contractors results in the federal government collecting significant financial penalties from employers, and the IRS aggressively auditing organizations to expose abuses. It is estimated that as much as $1.5 billion in income, Social Security withholdings and unemployment tax revenue is lost annually due to misclassification of as many as 3.5 million workers as independent contractors.
Organizations judged by the IRS to have misclassified employees as independent contractors face all of the following consequences:
The organization is not entitled to collect these amounts from the alleged independent contractor.
The IRS Test: In addition to the factors considered by California agencies, the IRS examines its own set of factors to determine if an individual is an independent contractor. Moreover, the IRS weighs the factors differently from its California counterparts. When determining the level of control and independence of workers, the IRS generally looks at the following factors:
You must consider all of these factors, along with the factors outlined in the California common-law test, before deciding to classify a worker as an independent contractor.
Always document how you analyze each factor while making your determination. If you wrongly classify an employee as an independent contractor, the IRS can hold you liable for employment taxes.
The IRS website provides extensive guidance on properly classifying a worker as an independent contractor. Please note that you must satisfy California’s test as well as the IRS test — they are not mutually exclusive.
Defining Independent Contractors With Help From the IRS and EDD: Both the IRS and the EDD will provide a written determination as to whether a worker is an employee or an independent contractor for tax withholding purposes. When you request a determination for federal tax purpose, the IRS provides Form SS-8 - Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to fill out. When you request a determination for state tax purposes, the EDD provides Form DE 1870 - Determination of Employment Work Status for Purposes of State of California Employment Taxes and Personal Income Tax Withholding but also will accept the IRS’s Form SS-8 . Contact your local IRS or EDD office for copies of these forms.
Though forms SS-8 and DE 1870 can be helpful for a self-audit, do not use them to seek a written determination from the IRS or EDD. The agencies will likely find an employment relationship exists, and you can become subject to an audit as a result of requesting a written determination. Consider using the Form SS-8 as an internal tool to determine what factors the IRS and EDD consider in evaluating if a worker is an employee or an independent contractor. Another alternative is to use EDD’s Form DE 38 - Employment Determination Guide , a worksheet designed for a business proprietor to use while conducting a self-audit.
In Air Couriers International et al v. Employment Development Department , an employer issued a complaint against the EDD for recovery of unemployment taxes paid for what the organization claimed were independent contractors. However, the complaint backfired. A California Court of Appeal found that the individuals were actually employees. The simplicity of the work involved (package delivery) made detailed supervision and control unnecessary. The drivers worked regular schedules, were not involved in a separate profession or operating their own business and did not make major investments in materials or equipment. Additionally, the job they performed was an integral and entirely essential aspect of the business.
Defining Independent Contractor for Unemployment and Disability Insurance: For the purposes of unemployment and disability insurance the Employment Development Department (EDD) defines an employee as an individual who, under usual common-law rules, has a status of an employee. The EDD applies the California right of control test and, where right of control is not readily apparent, examines the list of secondary factors.
If individuals classified as independent contractors are found to be employees, you will be assessed for amounts due for unemployment insurance contributions, disability insurance contributions and state income tax withholding amounts. In addition, if you, without good cause, fail to pay required contributions for unemployment or disability insurance benefits, you are liable for a penalty of 10 percent of the amount of the contributions (plus interest) on any unpaid contributions.
Licensure and Contractors: There is a presumption that where an unlicensed worker performs services that require a license, that worker will be considered an employee and not an independent contractor. This will be true even if you are using a licensed contractor and then his/her license expires.