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IRS 20-Factor Test – What Employers Should Know

Posted by Eric Kingsley | Mar 21, 2021 | 0 Comments

As the use of part-time employees and independent contractors continues to grow in California, it is critical for employers to understand the differences in types of employment status. Using an independent contractor classification test might be helpful in certain circumstances.  One tool at an employer's disposal is the IRS 20-factor test, used to determine whether sufficient "control" is present to establish an employer-employee relationship or an independent contractor-client relationship.

Contract Vs. Employee

By definition, an independent contractor is a worker who individually contracts with an employer to provide specialized or requested services on an as-needed or project basis. This individual is free from control and direction of the performance of their work, and the individual is customarily engaged in an independent trade, occupation, profession, or business.

Independent contractors have greater control over the way they carry out their work than employees and employers assume fewer duties with respect to independent contractors than employees. Independent contractors are generally outside the coverage of various laws that apply to the employer-employee relationship.

An employer must exercise extreme caution when classifying a worker as an independent contractor. This is especially important when it comes to issues such as pension, workers compensation, and wage and hour law.

Employers do not withhold federal, state and local taxes from wages paid to independent contractors, they are not included in an employer's benefits programs, are exempt from wage and hour, employment discrimination laws and unemployment insurance. Therefore, the penalties for misclassifying a worker can be huge. Penalties can include back taxes or premiums, civil fines, interest, and other retroactive damages.

The IRS 20-Factor Test

The 20-factor common law test set forth in IRS Revenue Ruling . 87-41, 1987-1 CB 298 is what the IRS generally looks at to determine whether a worker is an employee or an independent contractor. No single factor is used to determine the status of a taxpayer or their relationship to another taxpayer.

According to the IRS, the 20 factors below should be considered guidelines. Not every factor is applicable in every situation, and the degree of importance or "weight" of each factor varies depending on the type of work and individual circumstances. However, all relevant factors are considered by the IRS in probing the relationship; no one factor is decisive.

Factor Indicates Employee Status Indicates Independent Contractor Status
Instructions Worker must comply with company's significant instructions. Worker determines when, where, and how the work is performed.
Worker is required to undergo on-the-job training.
Worker is already highly skilled and receives no company sponsored training.
Integration Worker's services are integral to the overall business and are similar to work done by regular full-time employees. Worker's services are not integral to the success or continuation of the business and are separate and distinct from work done by regular full-time employees.
Services Rendered Worker must personally render the services.
Worker does not have to render services personally and may involve helpers.
Company hires, supervises, and pays workers. Worker hires, supervises, and pays helpers under a contract requiring him/her to provide materials and labor.
Employment Relationship
Relationship between worker and company is continuing.
Relationship exists only until specific project is completed.
Work Hours Company sets work hours. Worker sets his/her own work hours.
Full-time Effort Worker must devote full-time effort to company. Worker determines when and for whom he or she chooses to work.
Location Work is performed on company premises. Work is performed on or off company premises.
Company sets order or sequence of work performed. Worker follows his/her own pattern or schedule of work.
Reports Worker must submit regular oral or written reports. Regular reports are not required.
Payment Method Worker is paid hourly, weekly, or monthly. Worker is paid by the job or by straight commission.
Expense Reimbursement Company reimburses worker for business or travel expenses. Worker pays his or her own expenses.
Tools and Materials Company provides worker's tools and materials. Worker furnishes his or her own tools and materials.
Significant Investment Worker does not invest in facilities and/or equipment used to provide services. Worker makes significant investment in facilities and/or equipment he/she uses in performing services.
Profit or Loss Worker cannot make a profit or loss. Worker can realize a profit or loss under the contract.
Employed by More than One Firm Worker provides services to one company. Worker provides services to multiple, unrelated companies at the same time.
Service Availability Worker does not regularly make services available to the general public. Worker regularly makes services available to the general public.
Firing The right to discharge is an indicator of an employer-employee relationship. Worker may not be fired if work is produced according to contract specifications.
Quitting Each party has the right to terminate the relationship without incurring liability. Worker may terminate the relationship only upon completion of contract or breach of contract by other party.

Getting Help From An Experienced Law Firm

Are you an employer concerned about how your employees are classified? Or are you a worker currently classified as an "independent contractor" with questions about your rights and compensation?  If so, don't hesitate to contact leading California employment lawyers from Kingsley & Kingsley Lawyers to take advantage of a free initial consultation. To discuss your situation, call our employment law firm toll-free at (818) 990-8300 or click here to contact us regarding your case.

About the Author

Eric Kingsley

Eric B. Kingsley is a 2023 "Best In Law" Award winner and has litigated over 150 class actions. He is also an AV peer rated attorney and a prolific speaker at various seminars on employment law.


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