Employee or Contractor?
Many Factors Determine the Answer
Does your firm use outside workers for some jobs? This can result in
significant savings if the workers are properly classified as
independent contractors rather than employees.
If a worker is an employee, your company must withhold federal income
tax and employment taxes from his or her wages. In addition, your
business is responsible for paying the employer's share of federal
payroll taxes. Conversely, if a worker is characterized as an
independent contractor, your company isn't liable for these
payroll tax obligations.
Court: Drivers Are
Into Company's Operation
The California Appeals Court ruling earlier this year stated: "FedEx's
control over every exquisite detail of the drivers' performance,
including the color of their socks and the style of their hair,
supports the trial court's conclusion that the drivers are employees...
According to court documents, here are
some of the requirements of the drivers under the terms of their
written contracts with the company.
- Drivers were
required to provide their own trucks meeting FedEx's specifications,
mark them with the company logo, pay all costs of operating and
maintaining the vehicles (including repairs, cleaning, fuel, tires,
taxes, licenses and insurance).
- The drivers had
to wear uniforms and use specific scanners and forms, all obtained from
FedEx and marked with the company's logo. (The trial court also noted
that FedEx provided business cards for the drivers with its logo.)
- To pay for the
trucks and other required items, drivers could obtain loans through
FedEx's business support programs (with repayment through pay
- FedEx offered
drivers a deferred compensation or retirement plan and other "employee
benefits" (including direct deposit, a seniority-based "time-off
program" for unpaid leave, and a scholarship program for their
- The drivers
worked full time, with regular schedules and routes and were required
to work exclusively for FedEx.
In practice, the court concluded: "The work performed by the drivers is
wholly integrated into FedEx's operation. The drivers look like FedEx
employees, act like FedEx employees, are paid like FedEx employees, and
receive many employee benefits." (Estrada vs. FedEx Ground,
Calif. Ct. of Appeal, B189031)
In addition, employers aren't required to offer independent contractors
the same fringe benefits that regular employees receive, which can
result in extra savings. And they generally provide their own equipment
However, it's not always easy to distinguish independent contractors
from employees. There are several factors the IRS and courts examine
but it often boils down to a "control" issue. If your business controls
how, where and when the worker does the job, he or she is usually
classified as an employee.
Corporation is the latest company caught in a series of
well-publicized court cases involving independent contractors. In
October, a federal judge allowed thousands of drivers to proceed with a
class action against the shipping firm on claims that they are
employees who are due full-time benefits under federal law.
And in November, the California Supreme Court denied FedEx's appeal to
overturn a state court that ruled that the shipping company's drivers
are employees, rather than independent contractors (see right-hand box
for details of the case).
FedEx must now pay the West Coast drivers more than $11 million in
expenses and interest. In similar cases, workers have sued companies
for benefits including health insurance and retirement plan
To make matters worse, the IRS continues cracking down on companies
that hire independent contractors. If the tax agency "reclassifies" a
worker as an employee, a company could be hit with large bills for back
taxes, interest and penalties. Audits by state agencies are also common
and frequently occur when independent contractors apply for
unemployment or Workers' Compensation.
no single factor determines a worker's status. The
IRS looks at a number of issues, such as:
Tools. An employer usually
gives tools, equipment and workspace to employees. In contrast,
subcontractors often provide and invest their own money in equipment,
tools and facilities.
Other customers. Independent
contractors generally make services available to the public and are
able to work for two or more businesses.
often have set work schedules, while contractors are allowed some
flexibility. (However, the IRS recognizes that some work, by its very
nature, must be done at specific times.)
don't hire and pay others to help them do their jobs. But contractors
often hire, supervise, and pay their own assistants.
Training. Employees are
more likely to receive training from an organization than independent
Employees are generally paid hourly or weekly, while contractors are
paid by the job. It's a good idea to require contractors to submit
invoices since they provide proof of non-employee status.
Employers that misclassify workers as independent
contractors can end up with substantial tax bills as well as penalties
for failing to pay employment taxes and file required forms. They may
also face employee benefit liability. Workers sometimes contact the IRS
to say they have been misclassified. (There is a form they can fill out
to ask for a determination of their status.)
Here are a few quick tips to help protect your business:
- Have written contracts
with independent contractors that spell out the details of the
- Once contracts are in
place, resist the urge to supervise
independent contractors in the same way you manage employees.
- Maintain good records.
You obviously need to keep information required by the IRS, such as
workers' taxpayer information numbers. But also keep items that can
help prove a person is self employed, such as business cards, newspaper
and yellow page advertisements, invoices and letterheads.
you have a question call Ronald J. Cappuccio, J.D., LL.M.(Tax) at (856)