Employee v. Contractor: What Closely-Held Business Owners Need to Know

Mistakenly classifying an employee as an independent contractor can result in significant fines and penalties.  The U. S. Supreme Court indicated, on a number of occasions, that there is no single rule or test for determining whether an individual is an independent contractor or an employee. Instead, the Court holds that the total activity or situation controls which label best fits – and which set of rules apply.  The primary factors which the Court considers significant are:

• The extent to which the services rendered are an integral part of the principal’s or employer’s business;
• The permanency of the relationship;
• The amount of the alleged contractor’s investment in facilities and equipment;
• The nature and degree of control by the principal or employer;
• The alleged contractor’s opportunities for profit and loss;
• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor; and
• The degree of independent business organization and operation.

Other factors are immaterial in determining whether there is an employee relationship or a contractor relationship, despite how dispositive they may seem:

• Where work is performed;
• The time or mode of pay;
• Whether the worker receives an IRS Form 1099 or an IRS Form W-2;
• Whether there is a formal employment (or contractor) agreement; and
• Whether an alleged independent contractor is licensed by state or local government.

None of these are considered to bear on whether there is an employment relationship.

Additionally, the IRS states that it is the control that the principal or employer has over the worker which is the determinative issue.  The IRS provides guidelines on whether an employer has sufficient control over a worker to consider that worker an employee.  Though these rules are intended only as a guide – the IRS says the importance of each factor depends on the individual circumstances – they can be helpful in determining whether the principal or employer wields enough control to show an employer-employee relationship.

If you are considering creating a business with an expectation of bringing on help, or if you own a closely-held business and are looking to expand, please give contact us.  Our office can review employment or independent contractor agreements or assist you with crafting the right agreement for your situation or business.

About the Author

S. Blaydes Moore, JD
Associate Attorney