Independent Contractor or Employee? – Relationship of the Parties

This is the fifth 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 relationship of the parties factors.

The relationship of the parties factors are related to how the worker and the business perceive their relationship to each other.

1. Employee benefits. If a worker received employee-type benefits such as paid vacation days, paid sick days, health insurance, life or disability insurance, or a pension, this constitutes evidence of employee status. The evidence is strongest if the employee is provided with benefits under a tax-qualified retirement plan, 403(b) annuity, or cafeteria plan, as only employees can receive these benefits.

2. Written contracts. A written agreement describing the worker as an independent contractor is viewed in these decisions as evidence of the parties’ intent. However, the facts and circumstances under which a worker performs services are determinative of the worker’s status.

3. Permanency. The element to look for in determining permanency is whether the business engages a worker to perform a particular job or complete a particular project with the expectation that the relationship will terminate (or require explicit renewal) upon completion of the job or project.

4. Discharge/termination. The right to discharge the worker without incurring a penalty demonstrates the business’ ability to control means and details of how the work was performed. The worker’s right to terminate work without incurring a penalty illustrates that the worker merely provided labor and was not obligated to produce an end product.

It is difficult to distinguish discharging a worker for failure to perform work properly and terminating a contract for failure to produce the contracted product. Mere inability to discharge a worker at will does not necessarily create evidence of independent contractor status. If a contract contains a meaningful liquidated damages provision, this can be helpful evidence that the worker was engaged to produce a product and may be an independent contractor. But, if there is an industry practice of not enforcing these provisions, they should be disregarded.

5. Regular business activity. If the services the worker performs are part of the company’s regular business, it is likely that the company will wish to control how those services are performed.