This is the fourth post in the Independent Contractor/Employee series. This series is dedicated to presenting individuals, sole proprietorships, and small to large businesses with a basic understanding of independent contractor issues.
Revenue Ruling 87-41 states the factors the IRS considers when whether a worker is an independent contractor or employee. These factors are divided into three groups: behavioral control, financial control, and relationship of the parties. This article focuses on the financial control factors.
The financial control factors are related the economic aspects of the relationship, including:
- Significant investment
- Unreimbursed expenses
- Services available to the public
- Method of payment
- Opportunity for profit or loss
1. Realization of profit and loss. The ability to realize a profit or incur a loss is probably the strongest evidence that a worker controls the business aspects of services rendered.
2. Method of payment. The method of payment is extremely important in determining whether the worker has the opportunity for profit or loss.
- a. Salary or hourly wage. The worker is guaranteed a return for labor costs. Salary or hourly wage is usually more indicative of employee status.
- b. Flat fee or Per job basis. The worker is paid a fee per each job completed. Variation in the amount of the flat fee is usually indicative of independent contractor status.
- c. Commissions. Depends on the worker’s ability to realize a profit or incur a loss as a result of services rendered and can be indicative of either employee or independent contractor status.
3. Economic loss. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. If the worker uses capital, markets services, controls expenses, and makes business decisions, the worker has the ability to realize a profit or loss.
4. Economic dependence. The question is whether the recipient of the services has the right to direct and control business-related means and details of the worker’s performance. If so, it is more likely that the worker is an employee.
5. Significant investment. A significant investment is evidence that an independent contractor relationship may exist. Some types of work simply do not require costly equipment. An independent contractor may rent the equipment needed from a third party.
6. No dollar limitation on investment. Does the investment have substance?
7. Personal items used for business. This is less persuasive evidence than investment in items suited only for business purposes.
8. Business expenses. Does the worker pay for business expenses? These may include:
- a. Rent and utilities;
- b. Tools and equipment;
- c. Training Advertising;
- d. Wages or salaries of assistants;
- e. Licensing;
- f. Insurance;
- g. Postage and delivery;
- h. Repairs and maintenance;
- i. Supplies;
- j. Travel;
- k. Leasing of equipment; and,
- l. Depreciation.
The extent to which a worker chooses to incur these expenses and bears their costs, impacts the opportunity for profit or loss and constitutes evidence that the worker has the right to direct and control the financial aspects of the business operations. If expenses are unreimbursed, then the opportunity for profit or loss exists.
9. Services available to public. An independent contractor is generally free to seek out business opportunities and normally does so through advertising. However, the fact that the worker does not advertise does not necessarily contradict independent contractor status.