When a business contracts someone for services, it is important for both parties to have a clear understanding of whether that person is an employee or independent contractor. Failure to do so can lead to significant legal and tax consequences. For example, employers are required to withhold income taxes for employees, but not for independent contractors. Incorrectly classifying someone as an independent contractor may make the employer liable to the IRS for those taxes. Additionally, independent contractors generally do not receive the same benefits as employees such as minimum wage, overtime, and pension eligibility.
There is no bright-line test for determining whether a worker is considered and employee or independent contractor, though several methods are frequently used. Some agencies use the “economic reality” test, a five-part test established by the United States Supreme Court. Another approach is the “ABC” test, used by a number of states (excluding Texas).
The Texas Workforce Commission (TWC) uses a 20-point comparative approach in determining the classification of a worker. It is important to note that the TWC presumes a person is an employee, and it is up to an employer to prove otherwise if challenged. The following is a brief summary of some the 20 factors TWC looks at to determine employment status:
- Instructions: Generally, an independent contractor performs his or her job with few, if any, instructions as to the details of work. An employee, by comparison, receives instruction on how and when work is done.
- Training: Employees are typically trained by the employer or are required to take training courses, whereas an independent contractor relies on his or her own methods.
- Set Hours: An independent contractor works the time and days he or she chooses; an employee works hours as set by his or her employer.
- Payment: An employee’s pay is typically set by the employer in regular amounts and at given intervals. Independent Contractors are typically paid by the job.
- Tools and Equipment: An independent contractor will provide all equipment necessary to perform his or her duties, while an employee is furnished the required tools and materials by the employer.
- Location Where Services Performed: An employer has the right to mandate where an employee’s services are performed. Independent Contractors generally get to work where they choose.
- Working for More Than One Firm: Employees normally work for one employer at a time and may be subject to a non-compete. It is common for independent contractors to work for more than one client or firm at the same time.
- Realize Profit or Loss: Employees are paid for services rendered, and do not generally realize a profit or loss in the business. Independent contractors can either realize a profit or suffer a loss.
Other factors the TWC looks at in its comparative approach are whether the person has a significant investment in the business, if a continuing relationship exists, whether services are rendered personally or may be assigned to others, and whether the employer has the right to discharge without liability.
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