Classification
Understanding contractor vs employee classification
The IRS uses a three-factor test to determine if a worker is an independent contractor or an employee. Misclassification can result in significant penalties and back taxes.
Behavioral Control
This factor examines whether the business has the right to direct and control how the work is done.
- Instructions provided on when, where, and how to work
- Training provided on methods to perform the work
- Evaluation systems that measure how the work is performed
- Degree of instruction - more instruction suggests employee status
Financial Control
This factor looks at whether the business has the right to control the economic aspects of the worker's job.
- Significant investment in equipment or facilities
- Unreimbursed expenses
- Opportunity for profit or loss
- Services available to the relevant market
- Method of payment (flat fee vs hourly wage)
Relationship Type
This factor considers how the business and worker perceive their relationship.
- Written contracts describing the relationship
- Benefits provided (insurance, vacation, etc.)
- Permanency of the relationship
- Services provided as a key activity of the business
Key Takeaway
No single factor determines classification. The IRS looks at the entire relationship. When in doubt, consult with a tax professional to avoid costly misclassification penalties.