Many business owners have heard of the IRS’s 20 Factor Test… but what exactly is it, and what is the purpose? The 20 Factor Test is a list of 20 different factors IRS auditors use to analyze a business before concluding whether a sufficient level of control is present to create an employer-employee relationship.
As an employer, these 20 questions are useful in determining whether your workers are employees or independent contractors. Employees bring forth payroll tax obligations, and independent contractors do not, and misclassifying a worker as an independent contractor can result in the imposition of fines, penalties, and back-taxes, should you be audited by the IRS.
Try and assess the following 20 factors as honestly as possible and they will be helpful in determining whether or not you are inheriting any risk by treating a worker as an independent contractor. Each factor is designed to evaluate who controls how work is performed. Under IRS rules, independent contractors control the manner and means by which services are achieved. The more control a company has over, when, where, and by whom the work is performed, the more likely the workers are employees.
A worker does not have to meet all 20 criteria to qualify as an employee or independent contractor, and no single factor is decisive in determining a worker’s status–The individual circumstances of each case determine the weight IRS auditors may assign to different factors. It is recommended that you rely on a tax professional to help you, or request an IRS determination by filing Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
- Instructions. Workers who are required to comply with others’ instructions about when, where, and how they are to work are ordinarily employees.
- Training. Training workers indicates that employers exercise control over the means by which results are accomplished.
- Integration. When the success or continuation of a business depends on the performance of certain services, the workers performing those services are subject to a certain amount of control by the owners of the businesses.
- Services rendered personally. If services must be rendered personally, employers control both the means and the results of the work.
- Hiring, supervising, and paying assistants. Control is exercised if employers hire, supervise, and pay assistants.
- Continuing relationships. Continuing relationships between workers and employers indicate that employer-employee relationships exist.
- Set hours of work. The establishment of set hours of work by employers indicates control.
- Full-time required. If workers must devote full time to employers’ businesses, employers have control over workers’ time. Independent contractors are free to work when and for whom they choose.
- Doing work on employers’ premises. Control is indicated if the work is performed on employers’ premises.
- Order or sequences set. Control is indicated if workers are not free to choose their own patterns of work but must perform services in the sequences set by the employers.
- Oral or written reports. Control is indicated if workers must submit regular oral or written reports to employers.
- Payment by hour, week, or month. This points to employer-employee relationships, provided that this method of payment is not just a convenient way of paying a lump sum agreed on as the cost of a job. Independent contractors are usually paid by the job or on straight commission.
- Payment of business and/or traveling expense. Employers paying workers’ expenses of this nature shows that employer-employee relationships usually exist.
- Furnishing tools and materials. If employers furnish significant tools, materials, and other equipment, employer-employee relationships usually exist.
- Significant investments. Workers are independent contractors if they invest in facilities that are not typically maintained by employees (such as an office rented at fair market value from an unrelated party). Employees depend on employers for such facilities.
- Realization of profits or losses. Workers who can realize profits or losses (in addition to profits or losses ordinarily realized by employees) they are independent contractors. Workers who cannot are generally employees.
- Working for more than one firm at a time. If workers perform services for a number of unrelated persons at the same time, they are usually independent contractors.
- Making services available to the general public. Workers are usually independent contractors if they make their services available to the general public on a regular and consistent basis.
- Right to discharge. The right of employers to discharge workers indicates that the workers are employees.
- Right to terminate. Workers are employees if they have the right to end their relationships with their principals at any time without incurring liability.
For additional information on the 20 Factor Test, review “Law and Background Relating to Worker Classification for Federal Tax Purposes,” provided by the IRS.