How To Classify a Contract Worker

In today’s business environment, some offices and businesses utilize freelance contract workers who work independently to fill up an immediate and temporary need for additional workforce. In some, they hire the services of placements agencies to provide them with temporary workers to fill up a sudden vacancy.

Federal and tax laws mandate that employers must determine if a worker is considered a freelance contract worker or an employee. The Department of Labor uses an “economic reality test” to determine how a worker is going to be classified. The Internal Revenue Service on the other hand uses a “20-step statutory test.”

  • The economic reality test used by the Department of Labor relies on just five factors, namely:
      • The extent in which the services rendered becomes an essential part in running the business the employer is engaged in
      • How permanent is the business relationship
      • The amount spent by the worker in facilities and equipment
      • The opportunity for profit and loss that exists for the worker
      • The initiative, foresight and/or judgment the worker extends while performing his/her services
  • The IRS has a different set of criteria in determining how to classify a worker. They look at the following to check the relationship between the employer and the worker:
      • Behavioral control - whether the employer has the right to control and direct the worker on how to perform the task he was hired to do through training and instructions
      • Financial control - how the employer controls or directs the business aspects of the worker’s activities such as method of payment, unreimbursed expenses, investment, profit and loss opportunities
      • Relationship of the parties - existence of written contracts, payment of employee benefits, discharge/termination
  • The IRS also looks into relationship where a contractor can be classified as an employee:
      • Freelance contractors invest their time and money without a guarantee of success for the task he was hired to do but when a worker is restricted in the amount he can gain from the performance of his job and protected from loss, he is an employee.
      • A worker is classified as an employee when he is hired for an indefinite period, including work/service performed irregularly but is recurring as well as seasonal, temporary and part time jobs.
      • Compliance with another person’s instructions on how, when and where to perform a job makes him an employee.
      • If he is required to be trained by another employee, correspond with the employer and attend training courses and sessions, he is classified as an employee.
      • Rendering the service in question personally makes the hired worker an employee.
      • There are other indicators that will suggest that a worker is classified as an employee such as when the worker’s services and tasks are contributing to the success of the employer’s business; hiring assistants for the worker; requiring set hours of work and giving full time work requirement; working on the employer’s place of business even if the work can be done elsewhere; required to work on a sequence or a set order.
      • A worker that is required to submit reports, paid by the hour, week or month, paid travel and business expenses and provided with a set of tools and equipment to perform his tasks is classified as an employee.  If he can be terminated or discharged from job, then he is an employee.
  • A freelance contractor on the other hand is one who uses his own finances to finish the task he was hired to do, contracts with other firms, and is available to the general public.

It is very vital that you as the business owner make the correct distinction whether the person you hire is going to be your permanent employee or is technically a freelance contractor. This is the basis for payments as well as the withholding of income taxes, Medicare, Social Security and other allowed employee deductions.


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