Employee or Contractor? 6 Mistakes When Classifying Workers

Image by mohamed Hassan from Pixabay


From Insperity, Marsha Bustos identifies 6 common mistakes in classifying workers, reviews the standards, and offers terrific guidance. These are the 6 mistakes and Marhsa’s review of the first one. Marsha writes:

Mistake 1: Not considering all aspects of the company-worker relationship

To properly classify your workers, you must consider all aspects of the worker-company relationship. You shouldn’t base your classification decision on only one factor.

After all, the U.S. Supreme Court has, on a number of occasions, indicated that there is no single rule or test for determining whether a worker is an employee or contractor. The court has stated that it’s the total activity or situation that controls the classification.

In determining whether a worker is an employee or contractor, evaluate the amount of control over the details of the work performed.

  • The more control a company exerts, the more likely it is that the worker is an employee.
  • When a company exerts almost no control, then it’s more likely a worker is an independent contractor.

3 categories that the IRS considers

1. Behavioral: Does the company have the right to direct or control how a worker does the work?

Consider whether workers receive extensive instructions on how work is to be done. Examples:

  • Hours and location of work
  • Tools and equipment to use
  • Who to hire to help assist with the work
  • Where to purchase supplies

Also consider whether a company provides a worker with training about procedures and methods.

If a company gives detailed instructions and provides training, that’s a good indication the worker is an employee.

2. Financial: Does the company have the right to direct or control the business part of the work?

Look at these factors:

  • How much money – known as a significant investment – has a worker invested into their work using their own money? (Note: There’s no precise minimum dollar amount required. Significant is open to interpretation.)
  • Is a worker reimbursed by the company for their expenses associated with their work?
  • Does the worker realize a profit or incur a loss?

A worker spending their own money and not receiving reimbursement, and incurring profits and losses, is indicative of a contractor.

3. Type of relationship: What are the facts that demonstrate how the company and the worker perceive their relationship?

Does the worker receive employee benefits, such as insurance, retirement savings plans or a pension and paid leave?

If a worker receives benefits, they’re an employee. However, as we’ll discuss later, if a worker doesn’t receive benefits, they could be either an employee or a contractor.

Is there a written contract describing the relationship?

The U. S. Supreme Court’s criteria

To further clarify, the U.S. Supreme Court has listed these factors as significant in classifying workers:

  • The extent to which services rendered are an integral part of the company’s core business
  • The permanency of the relationship
  • The amount of the worker’s investment in facilities and equipment
  • The nature and degree of control by the company
  • The worker’s opportunity for profit and loss
  • The amount of initiative, judgment or foresight in open-market competition with others that’s required for success
  • The degree of independent business organization and operation

How does this play out in real life?

Now let’s use an example. Upon discovering a plumbing issue in their facility, Waffle World hires Bill Jones, a local plumber, to unclog their drains.

Based on these facts, how should Bill be classified?

  • Bill’s work is completely different than Waffle World’s core business.
  • Waffle World has little control over the behavioral aspects of his job (what he does and how he does it).
  • Bill owns and pays for his own equipment.
  • This isn’t a one-time job for Bill. Waffle World decides to hire Bill to return once per month to flush the company’s drain, and pays him $600 per month for this service.

Answer: Bill should be classified as an independent contractor.

However, if Waffle World considered only his recurring employment and monthly wage, he could be wrongly classified as an employee.

Mistake 2: Basing worker classification solely on written contracts

Mistake 3: Improperly defining a “significant investment”

Mistake 4: Paying employees and contractors similarly

Mistake 5: Viewing benefits as the determining factor

Mistake 6: Relying on industry standards


Read the full story at Employee or Contractor? 6 Mistakes When Classifying Workers – Insperity

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