A frequent audit issue for businesses is employee v. independent contractor. The results can be very burdensome because an incorrect classification can cause back taxes and penalties. The problem is that in most cases it is not a bright line test. There are cases such as sub-contractors working under the license of a contractor that are statutory employee relationships, but these are unique and most employers must make this decision on their own.
Under the IRS and California tax rules, workers are presumed to be employees and it is the employer’s responsibility to prove there is an independent contractor relationship. Proving this relationship is an intensive weighing of factors, with over 20 considered as part of the IRS analysis. No one factor is determinative, which can make this a difficult decision.
Recently, the California Supreme Court set out to simplify this analysis in the Dynamex case. In the decision the court set out these three factors to be considered an independent contractor:
- the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- the worker performs work that is outside the usual course of the hiring entity’s business; and
- the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
While this was a California decision, it is likely the IRS would follow a similar analysis. The conservative approach is to err on the side of employee and only classify as an independent contractor when it is obvious. In either case, hopefully this recent court decision has provided a more focused analysis for employers.