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IRS Independent Contractor Test -
Contractor or Employee?





Introduction to Independent Contractor Test Criteria
The workplace changes constantly and through time it has become more difficult to distinguish between different types of worker.

A number of test cases have been brought before the courts and case law has built rapidly that helps to define the characteristics of employed roles, temporary roles, contractor roles and consulting assignments.

Set out below is a summary of the main independent contractor test criteria. Unfortunately, there is often a degree of ambiguity - few cases are black and white. In ruling on a particular case, consideration is likely to be given to the full suite of independent contractor test criteria.

Independent contractor test criteria are broadly similar on both sides of the Atlantic:
  • in the U.S. a contractor will need to satisfy the IRS guidelines: the IRS Independent Contractor Test, sometimes referred to as the IRS Twenty Factor Test, recently simplified (refer IRS Publication 15-A)
  • in the UK the contractor needs to satisfy the requirements of HM Revenue and Customs through passing the IR35 tests

It is important to do as much as possible to meet the independent contractor test criteria and thereby protect your independent status. To trade independently for a period of years only to find that the IRS or HM Revenue and Customs determine that your relationship with your clients has in fact been one of employee / employer can be very costly.

It is important not only to demonstrably operate your consulting practice to satisfy the independent contractor test criteria but also that your standard independent consulting contract reflects the requirements as closely as possible.



Independent Contractor Test Criteria:


1. Business Expenses - Method of Calculation and Payment
Contractors are required to estimate their expenses for an assignment in advance and invoice the client to recover actual expenses incurred. Contractors typically make their own arrangements and bookings for travel and accommodation, or engage a personal assistant or independent travel agent at their own expense.

Employees are automatically reimbursed expenses as part of the monthly pay cycle. Making use of an outsourced corporate travel agency service, for example for booking hotels and flights, indicates employee status.

2. Ongoing or Recurring Relationship
A recurring relationship or engagement tends to indicate employee status. This can be the case even if assignments with a particular business occur at irregular intervals.

3. Working for Multiple Clients with Overlapping Contracts
A pivotal independent contractor test is whether a contractor works with more than one client concurrently; if so then this strongly reinforces independent status.

4. Training
Provision and funding of training by the client business indicates employee status.

5. Reports
Being required to prepare and submit regular progress reports tends to indicate employee status.
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6. Hours of Work and Overtime
If the client prescribes set working hours then this indicates employee status.

An independent contractor or consultant will have discretion to work hours only as required to complete the deliverables as specified in the consulting contract.

Extending this theme, payment of overtime indicates employee status. Contrast this with a contractor who will be paid a fixed fee that can be directly related to the completion of key outputs or deliverables. If the contractor needs to invest additional time to complete the job by a particular deadline then he must do this at his own expense - a tangible manifestation of the commercial risk that is inherent to working as an independent contractor.

7. Approach taken
Being required to adhere to guidelines or instructions from the client as to how work will be undertaken, for example the order in which tasks will be completed, indicates employee status.

An independent contractor will have complete discretion as to how to tackle the assignment - all that should be of interest to the client is the final outcome, completed in line with the delivery date agreed as documented in the contract.

8. Assistants, Associates and Subcontractors
Being able to subcontract or delegate activities or tasks to subordinate resources that are paid for by the contractor strongly reinforces the contractor's independent status.

The acts of identifying a resource need, sourcing an individual, entering into contract with them, overseeing their work and paying their invoices all indicate (lead) contractor status rather than employee.

9. Integration with client business
The extent to which the activities of the contractor are viewed as integral to the core operations (business as usual) of the client's business will influence rulings on contractor status.

Typically a contractor will be engaged to work on a Project or Programme, which by definition is a temporary entity and something that is separate from core business as usual activities.

10. Location at which work is undertaken
Working in a client office and being allocated a dedicated work station for an extended period tends to indicate a degree of control and therefore is suggestive of employee status.

If some of the work is performed away from client premises and on premises owned and controlled by the contractor, then this reinforces independent status.
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11. Payment - Triggers, Frequency and Method
Payments to independent contractors are triggered by the submission of invoices for services provided, with settlement being made in line with the terms of business as set out in the independent contractor agreement.

A strong commercial independent contractor agreement will also contain the right for the contractor to charge the client interest on late payment.

The contractor is typically paid per assignment, with interim invoices raised usually on a monthly basis.

An employee is typically paid on a monthly basis, net of withholding tax / PAYE.

12. Right of the Company to Terminate
The right of an organization to terminate the contract of service of a worker indicates employee status.

The tenure of an independent contractor will be determined explicitly by the contract terms set out in the independent contractor agreement.

The organization will be in breach of contract if it attempts to terminate the contract of an independent in a manner that is contrary to the requirements set out in the independent contractor agreement.

13. Right of the Individual to Terminate
If the individual has the right to terminate the relationship at any time, subject to a notice period, then this indicates employee status.

An independent contractor is contractually bound to complete an assignment and can only escape this responsibility to the extent and in the manner that is stipulated in the independent contractor agreement.

14. Own Independently Funded Working Facilities
The existence of a working facility or office quite separate and distinct from the client's premises and funded by the contractor tends to reinforce independent status.

Conversely, the absence of independent working facilities is suggestive of a degree of dependence on the client and therefore implies employee status.

15. Provision and Funding of Equipment and Materials
If the client funds and provides key items of equipment that are central to the work of the individual then this suggests employee status. Items might include a computer, telephone, workspace, printer, consumable stationery items.
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16. Exposure to Commercial Risk i.e. potential for profit or loss
Another pivotal independent contractor test - a genuine independent contractor will be exposed to the uncertainty as to whether he will make a profit or a loss on the assignment.

The strongest demonstration of independent status would be for a fixed fee to be agreed in consideration of clearly defined deliverables that are required by a fixed date.

An employee will typically not be exposed to the risk of profit or loss, but will be remunerated based on attendance and satisfactory performance of basic duties as specified in a contract of employment.

17. The Right of Substitution
An independent contractor will ordinarily have the right to substitute another in his place to discharge his responsibilities under the contract.

Again, independent status is reinforced if the client's focus is solely on getting the outcomes required by a set date rather than being concerned with the mechanics of delivery such as which individuals are undertaking the work and the approach taken.

Conversely, if there is a requirement that services must be undertaken personally by a named individual and no other, then this is suggestive of employee status.

18. Making services available to other Potential Clients
An independent contractor will make her services available to all potential clients and at any time may be actively involved in marketing and promoting her business.

This activity is reinforced if there is some significant financial investment in expenses of this type.

19. Requirement for Full time Attendance
If an individual is required to attend the business premises on a fulltime basis then employee status is implied. This is reinforced if the individual is expressly precluded from undertaking other work in parallel.

20. Meetings
Being required to attend regular meetings that are integral to everyday operations within the business would tend to indicate employee status.

Contractors can reasonably be expected to provide regular updates to internal client sponsors with respect to the project, key deliverables and progress against plan.

 



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