Employers "downsizing" their workforce often keep departing employees as ""independent contractors". Not only are "independent contractors" generally excluded from the company’s job benefits plans -- employers also are not required to pay FICA taxes for "independent contractors".

But there’s a catch: the tax authorities always suspect "independent contractor" arrangements -- especially those involving former employees. They say an employer-employee relationship exists if a person for whom services are performed has the right to control and direct the person performing the services -- both as to what shall be done and how.

The employer doesn’t have to actually direct or control the employee, so long as the employer has the right to do so. If the work is subject to the control or direction of the employer (only as to the result and not as to the means and methods of achieving that result) they generally will not be an employee. Decisions about whether someone is an employee or an "independent contractor" must be made on a case-by-case basis. The U.S. Internal Revenue Service uses 20 factors to make their decision.

No single factor is conclusive, so before you engage someone as an "independent contractor", consider these factors that indicate an employer-employee relationship:

• Will the people be required to comply (or does the company have the right to require compliance) with instructions as to when, where, and how the services are performed?

• Do the people need training by a more experienced employee so the services will be performed in particular method or manner?

• Will the services be integrated into the company’s business operations such that the business depends on these services?

• Must the services be performed by one person (implying that the method and results are relevant to the company)?

• Does their supervisor generally hire, supervise, and pay other employees as opposed to "independent contractors"?

• Is there a continuing relationship between the person and the company?

• Will they be required to work certain hours set by the company?

• Must they devote substantially full time to the company’s business?

• Will they be required to perform the services only on the company’s premises even if the work could be done elsewhere?

• Must they follow a sequence, routine, or schedule set by the company?

• Will they be required to submit regular status reports?

• Does the company pay for business and/or travel expenses?

• Will the company provide significant tools, equipment, or supplies?

• Does the company have the right to fire the contractor for reasons other than if the work fails to meet contract specifications?

• Does the employee have the right to end their relationship with the company at any time without liability?

On the other hand, the IRS says these factors favor treatment of the worker as an "independent contractor":

• Are they paid by the job or on commission, as opposed to being paid by the hour, week, or month (other than as interim payments on a fixed-price job)?

• Has the contractor made a significant investment in their own facilities, tools, equipment, or supplies?

• Can they realize a profit or suffer a loss in connection with the performance of the services, other than the risk and realization of profit or loss ordinarily incurred by employees?

• Do they perform services for other unrelated businesses at the same time?

• Do they make their services available to the general public?

As part of the Small Business Job Protection Act of 1996, Congress allowed taxpayers to treat employees as "independent contractors" under certain circumstances.  An employee treated as an "independent contractor" will not be reclassified as an employee for employment tax purposes if:

(1) the taxpayer has always treated the person as an "independent contractor";

(2) if the taxpayer has filed all required tax returns consistent with treating the person as an "independent contractor" and;

(3) the taxpayer had a reasonable basis for treating the person as an "independent contractor".

A company has a reasonable basis for treating someone as an "independent contractor" if the company relied on judicial precedent, rulings or technical advice published by the IRS or a private letter ruling issued to the employer.

A company may also rely upon a past IRS audit during which the IRS focused on employment tax issues regarding the same or similar employees and in which no assessment was made on account of improper treatment of the person.

Finally, the company may rely on a longstanding, recognized practice by a significant segment of the industry in which the company is engaged. The IRS has published a supplemental employment tax guide, Publication 15-A, which draws the distinction between employees and "independent contractors". To get a free copy of Publication 15-A, contact the IRS by phone at (800) 829-3676, by fax at (703) 487-4160, or at www.irs.ustreas.gov.   This article was written by Mr. Francis Parisi, a journalist and an attorney who practices in Massachusetts and Rhode Island.

June, 2005