Audit Manual, Ch 3, Sec 3.4 - Employee vs Independent Contractor Decision

3.4 Employee vs Independent Contractor Decision

An audit of an employer's records may uncover workers who have not been reported as employees to TWC. During the investigation, the Auditor must decide if the workers are employees, or if they are independent contractors operating their own independent businesses. Areas of common law may be used when making a determination regarding employment vs. independent contractor status. Those common law areas address behavioral control, financial control, and the relationship existing between the worker and the business.

Consider the following items before making a decision about whether an employer/employee relationship exists.

Direction and control - Under the common-law test, a worker is an employee if the person for whom the work is performed has the right to direct and control the worker in the way the worker works both as to the final results and as to the details of when, where, and how the work is to be done. The employer need not actually exercise control, it is sufficient that the employer has the right to do so.
Continuing relationship - An employee continues to work for the same person month after month or year after year. An independent contractor is hired to do one job of limited or indefinite duration, and there is no continuing relationship, even if used again at some later date.
Full-time required - An employee may be required to devote full time to the business of the employer. An independent contractor works when and for whom he chooses.
Furnishing tools and equipment - An employer furnishes tools, materials, equipment, etc. for the firm's employees. If a person is obligated to provide equipment and tools representing a substantial investment, it indicates an independent contractor relationship.
Hiring, supervising and paying assistants - An employee may hire, supervise, and pay workers at the direction of the employer (such as a foreman or supervisory representative of the employer). An independent contractor hires, supervises, and pays other workers as a result of a contract to provide materials and labor and is responsible for the results.
Instructions - An employee receives instructions about when, where, and how work is to be performed, or perhaps where to purchase supplies and services. An independent contractor does the job their own way without any kind of instructions as to details or methods.
Integration - Services of an employee are merged into the overall business, and the success and continuation of the business depends upon these services. The employer coordinates the work with that of other workers. The success and continuation of a business are not dependent on the services of an independent contractor.
Location of service - The service being performed on the employer's premises is not, in itself, control. However, control is implied in that the worker is physically within the employer's direction and supervision. The use of desk space and stenographic services provided by an employer implies control unless the worker has the option of performing the service at an alternate location. An independent contractor usually works away from the employer's premises, uses their own office, desk, telephone, or has the option of performing the services at a location of his choice.
Method of payment - An employee usually gets a fixed wage on an hourly or weekly basis. An independent contractor usually receives a lump sum payment for a completed job.
Minimum salary - Guarantee of a minimum salary usually indicates the existence of an employer-employee relationship.
Nature of the contract - An independent contractor is usually hired to do a specific job but a continuing relationship, even if occurring at infrequent intervals, suggests an employer-employee relationship.
Order or sequence set - An employee performs services in the order or sequence set by the employer. An independent contractor is concerned about the end result and sets the sequence as to how that result is accomplished.
Oral or written reports - An employee may be required to submit regular oral or written reports to the employer. An independent contractor submits no regular oral or written reports.
Payment by hour, week, month - An employee is paid by the employer in regular amounts at stated intervals. An independent contractor is paid an amount for the job.
Permitted to employ others - If a worker is permitted to employ assistants with the exclusive right to supervise and delegate to them, the independent contractor relationship is suggested. If the worker is required to render the services personally, an employer- employee relationship is suggested.
Profit or loss possible - A worker in a position to realize a profit or loss as a result of his services is generally an independent contractor. An employee cannot realize a profit or loss from a business, but an independent contractor can.
Reports required - If regular oral or written reports are required, control is implied in that the worker is compelled to account for actions taken.
Right to discharge at will - If the person paying for the services has the right to terminate the worker, an employer-employee relationship is indicated. An Independent contractor on the other hand, cannot be dismissed as long as the results measure up to the contract specifications.
Right to terminate - An employee may end the relationship with the employer at any time. An independent contractor is legally responsible for satisfactorily completing a specific job, and if the worker leaves before completing the job, that individual is liable for the cost of completion.
Services offered to the public - Workers who follow a distinct trade, business or profession, work under their own control and offer their services to the public are independent contractors, however if the worker is expected to work full time, an employer-employee relationship is indicated.
Services rendered personally - An employee's services must be rendered personally, as they are not able to engage other people to do the work. An independent contractor is able to assign a helper to do the job, or engage a substitute.
Services available to the general public - An employee's services are not available to the public except through the company. An independent contractor may have an office and assistants, business license, maintain a business telephone, advertise in newspapers or telephone directory, or be listed in business directories.
Set hours of work - An employee has work hours and days set by the employer, or is "on call" when needed. The employer may have a priority over the employee's time. An independent contractor is master of his own time.
Significant investment - An employee has little or no investment in their employer's business. An independent contractor has real, essential, and adequate investment in their independent business.
Time in which service performed - Establishment of set hours of work by the employer implies control. An independent contractor, however, is free to work at any time, as long as the job is being completed as required by the contract.
Training - An employee may be trained by an experienced employee already working for the firm, may have to attend training courses, or may be required to attend meetings for instruction on how the employer wants the services performed. An independent contractor uses their own methods and receives no training from the purchaser.
Travel expenses - An employee's travel or business expenses are paid by the employer. An independent contractor is responsible for expenses, and is not reimbursed for these costs.
Working for more than one firm at a time - An employee usually works for one employer. An independent contractor may work for a number of persons or firms at the same time.

SOME EXAMPLES OF EMPLOYEE vs INDEPENDENT CONTRACTOR DECISIONS

Building and Construction Industry

Example 1. Jerry Jones has an agreement with Wilma White to supervise the remodeling of her house. She did not advance funds to help him carry on the work. She makes direct payments to the suppliers for all necessary materials. She carries liability and workers' compensation insurance covering Jerry and others he engaged to assist him. She pays them an hourly rate and exercises almost constant supervision over the work. Jerry is not free to transfer his assistants to other jobs. He may not work on other jobs while working for Wilma. He assumes no responsibility to complete the work and will incur no contractual liability if he fails to do so. He and his assistants perform personal services for hourly wages. They are employees of Wilma White.

Example 2. Milton Manning, an experienced tilesetter, orally agreed with a corporation to perform full-time services at construction sites. He uses his own tools and performs services in the order designated by the corporation and according to its specifications. The corporation supplies all materials, makes frequent inspections of his work, pays him on a piecework basis, and carries workers' compensation insurance on him. He does not have a place of business or hold himself out to perform similar services for others. Either party can end the services at any time. Milton Manning is an employee of the corporation.

Example 3. Wallace Black agreed with the Sawdust Co. to supply construction labor for a group of houses. The company agreed to pay all construction costs. However, he supplies all the tools and equipment. He performs personal services as a carpenter and mechanic for an hourly wage. He also acts as superintendent and foreman and engages other individuals to assist him. The company has the right to select, approve, or discharge any helper. A company representative makes frequent inspections of the construction site. When a house is finished, Wallace is paid a certain percentage of its costs. He is not responsible for faults, defects of construction, or wasteful operation. At the end of each week, he presents the company with a statement of the amount he has spent, including the payroll. The company gives him a check for that amount from which he pays the assistants, although he is not personally liable for their wages. Wallace Black and his assistants are employees of the Sawdust Co.

Example 4. Bill Plum contracted with Elm Corporation to complete the roofing on a housing complex. A signed contract established a flat amount for the services rendered by Bill Plum. Bill is a licensed roofer and carries workers' compensation and liability insurance under the business name, Plum Roofing. He hires his own roofers who are treated as employees for federal employment tax purposes. If there is a problem with the roofing work, Plum Roofing is responsible for paying for any repairs. Bill Plum, doing business as Plum Roofing, is an independent contractor.

Example 5. Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6400. She also performs additional electrical installations under contracts with other companies, which she obtained through advertisements. Vera is an independent contractor.

Trucking Industry

Example. Rose Trucking contracts to deliver material for Forest Inc. at $140 per ton. Rose Trucking is not paid for any articles that are not delivered. At times, Jan Rose, who operates as Rose Trucking, may also lease another truck and engage a driver to complete the contract. All operating expenses, including insurance coverage, are paid by Jan Rose. All equipment is owned or rented by Jan, and she is responsible for all maintenance. None of the drivers are provided by Forest Inc. Jan Rose, operating as Rose Trucking, is an independent contractor.

Computer Industry

Example. Steve Smith, a computer programmer, is laid off when Megabyte Inc. downsizes. Megabyte agrees to pay Steve a flat amount to complete a one-time project to create a certain product. It is not clear how long it will take to complete the project, and Steve is not guaranteed any minimum payment for the hours spent on the program. Megabyte provides Steve with no instructions beyond the specifications for the product itself. Steve and Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to pay federal and state taxes, and receives no benefits from Megabyte. Megabyte will file a Form 1099-MISC. Steve does the work on a new high-end computer which cost him $7000. Steve works at home and is not expected or allowed to attend meetings of the software development group. Steve is an independent contractor.

Automobile Industry

Example 1. Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works 6 days a week and is on duty in Bob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob also pays the cost of health insurance and group term life insurance for Donna. Donna is an employee of Bob Blue.

Example 2. Sam Sparks performs auto repair services in the repair department of an auto sales company. He works regular hours and is paid on a percentage basis. He has no investment in the repair department. The sales company supplies all facilities, repair parts, and supplies; issues instructions on the amounts to be charged, parts to be used, and the time for completion of each job; and checks all estimates and repair orders. Sam is an employee of the sales company.

Example 3. An auto sales agency furnishes space for Helen Bach to perform auto repair services. She provides her own tools, equipment, and supplies. She seeks out business from insurance adjusters and other individuals and does all the body and paint work that comes to the agency. She hires and discharges her own helpers, determines her own and her helpers' working hours, quotes prices for repair work, makes all necessary adjustments, assumes all losses from uncollectible accounts, and receives, as compensation for her services, a large percentage of the gross collections from the auto repair shop. Helen is an independent contractor and the helpers are her employees.

Attorney

Example. Donna Yuma is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research linkup, fax machine, and photocopier. Donna buys office supplies and pays bar dues and membership dues for three other professional organizations. Donna has a part-time receptionist who also does the bookkeeping. She pays the receptionist, withholds and pays federal and state employment taxes, and files a Form W-2 each year. For the past 2 years, Donna has had only three clients, corporations with which there have been longstanding relationships. Donna charges the corporations an hourly rate for her services, sending monthly bills detailing the work performed for the prior month. The bills include charges for long distance calls, on-line research time, fax charges, photocopies, postage, and travel costs for which the corporations have agreed to reimburse her. Donna is an independent contractor.

Taxicab Driver

Example. Tom Spruce rents a cab from Taft Cab Co. for $150 per day. Tom Spruce keeps all fares he receives from customers. Although he receives the benefit of Taft's two-way radio communications equipment, dispatcher, and advertising, these items benefit both Taft and Tom Spruce. Tom Spruce is an independent contractor.

Last Revision: May 05, 2011

[ Audit System Manual- TOC ] [ Ch 1 - Introduction ] [ Ch 2 - Preparing for an Audit ] [ Ch 3 - Conducting the Audit ] [ Ch 4 - Completing the Audit Forms and Schedules ] [ Ch 5 - Audit System Screens ] [ Ch 6 - Miscellaneous ] [ Ch 7 - USDOL - Tax Performance System ] [ Ch 8 - Computer Fundamentals & Hardware ] [ Appendix ]
[ 3.1 - General Information ] [ 3.2 - Understanding the Payroll Flow ] [ 3.3 - Books and Records ] [ 3.4 - Employee vs Independent Contractor Decision ] [ 3.5 - Sample Audit Procedures] [3.6 - Minimum Audit Requirements of the TWC Tax Department & the Tax Performance System (TPS)] [3.7 - Post Audit Conference] [3.8 - Audit Report and Work Papers]
Chapter 3: Conducting the Audit	comments to: Tax Department

Chapter 3: Conducting the Audit

3.4 Employee vs Independent Contractor Decision