Building Your Business Business Taxes How the IRS Determines Independent Contractor Status Independent Contractor Tests Explained By Jean Murray Updated on September 19, 2022 Fact checked by Taylor Tompkins In This Article View All In This Article Why Is the Distinction Important? IRS vs. DOL Classification DOL Worker Status Test State Tests for Worker Status Getting a Review by the IRS Frequently Asked Questions (FAQs) Photo: /DreamPictures / Getty Images One of the most common errors businesses make is not having the correct status for a worker. The choices are an employee or independent contractor. An independent contractor (IC) is someone who is in an independent trade or profession offering services to the general public. An IC is considered to be able to control their own work, not the employer. By contrast, an employee's work is controlled and directed by the employer. Key Takeaways Employees and independent contractors are two types of workers your company can have. When you hire independent contractors, you do not have to pay certain taxes or adhere to certain laws. The Internal Revenue Service (IRS) and the Department of Labor (DOL) have different methods for determining which workers are contractors and which are employees. The IRS has distilled its 20-factor test to three main points, while the DOL looks for signs of an "employment relationship." Why Is the Distinction Important? Many businesses classify workers as independent contractors because it's cheaper than hiring employees. These businesses avoid: Withholding Social Security and Medicare taxes, and paying a portion of those taxesPaying premiums for unemployment insurance and workers' compensationAdhering to minimum wage, overtime, and other wage lawsBeing subject to employment laws like OSHA, ADA, and equal pay But misclassifying workers as independent contractors instead of employees can result in high costs, including paying workers' amounts owed for FICA taxes (Social Security and Medicare), and heavy fines and penalties. IRS vs. Department of Labor Classification The IRS separates and classifies workers as independent contractors or employees for employment tax purposes. As noted above, independent contractors are not subject to these taxes and businesses don't have to contribute to these taxes. The Department of Labor (DOL) uses a different classification system to determine worker status for purposes of wage and hour laws, including minimum wages, overtime, and child labor laws. Independent contractors are not subject to these laws. Note Because the IRS and DOL and states have different worker classification rules, a worker may be classified as an independent contractor under one rule and be classified as an employee under another. How the IRS Determines Worker Status The IRS uses common law principles to determine if a worker is an independent contractor or an employee. This IRS review relates to federal employment taxes—federal income tax, FICA taxes for Social Security and Medicare, and federal unemployment taxes. In the past, a "20 Factor Test" was used to evaluate workers to determine whether they were independent contractors or employees. These factors have been compressed into three general categories for IRS review of the specific situation: Behavioral controlFinancial controlRelationship of the parties Note The IRS presumes that a worker is an employee unless proven otherwise. So the burden of proof is on the employer to show that it has classified a worker correctly. As you look at the factors below, you should be aware that the IRS does not look specifically at any one factor, but one factor can be enough to cause the IRS to determine that a worker is an employee. There is no "magic number" of factors that determine status. IRS Factors for Determining Worker Status The IRS no longer uses this specific 20-question test to determine worker status, but it might help you to understand the details of what is being evaluated. Actual instruction or direction of the worker. A worker who is required to comply with instructions about when, where, and how to work is ordinarily an employee. The instructions may be in the form of manuals or written proceduresthat show how the desired result is to be accomplished. Training. Training of a worker by an experienced employee working, by correspondence, by required attendance at meetings, and by other methods is a factor indicating control by the employer over the particular method of performance. Integration of services. integration of the person's services in the business operations generally shows that he or she is subject to direction and control. Personal nature of services. If the services must be rendered personally, it indicates an interest in the methods, as well as the results. Lack of control may be indicated when the person has the right to hire a substitute with the permission or knowledge of the employer. Similar workers. Hiring, supervising, and payments to assistants on the same job as the worker generally show employer control over the job. Continuing relationship. The existence of a continuing relationship between an individual and the person for whom he or she performs services tends to indicate an employer-employee relationship. Hours of work. The establishment of set hours of work by the employer prevents the worker from being masters of their own time, which is the right of the IC. Full-time work. Full-time work required for the business indicates control by the employer since it restricts the worker from doing other gainful work. Work on the premises. If the worker is required to do the work on the employer's premises, employer control is implied, especially where the work is of such a nature that it could be done elsewhere. Order of performance. If the order of the performance of services is or may be set by the employer, control by the employer may be indicated. Submitting reports. The submission of regular oral or written reports indicates control since the worker must account for their actions. Method of payment. If the manner of payment is by the hour, week, or month, an employer-employee relationship probably exists; whereas, payment on a commission or job basis is customary where the worker is an IC. Payment of expenses. Payment of the worker's business expenses by the employer indicates control of the worker. Tools and materials. The furnishing of tools, materials, etc., by the employer, indicates control over the worker. Investment. A significant investment by the worker in facilities used in performing services for another tends to show an independent status. Profit or loss. The possibility of a profit or loss for the worker as a result of services rendered generally shows IC status. Exclusivity of work. Work for a number of persons at the same time often indicates IC status because the worker is usually free, in such cases, from control by any of the firms. Available to the general public. The availability of the services of the worker to the general public usually indicates IC status. Right of discharge. The right of discharge is that of an employer. An IC, on the other hand, cannot be "fired" without incurring liability if they are producing a result that measures up to their contract specifications. Right to quit. The right to quit at any time without incurring liability indicates an employer-employee relationship. U. S. Department of Labor Worker Status Test The DOL determines worker status by looking at whether an "employment relationship" exists between a worker and an employer. If this relationship exists, then the worker is considered to be an employee under the provisions of the Fair Labor Standards Act (FLSA). An employee in this context is not someone who has a business of their own but is dependent on the business they serve. The text of the employee-employer relationship under the FLSA is what the DOL calls "economic reality." Some of the factors that the Supreme Court has found to be significant, and which the DOL looks at, are: Whether the services of the worker are part of the basic business of the employerThe permanency of the relationshipHow much the worker invests in facilities and equipmentHow much control the employer has over the workerThe worker's opportunity for profit and lossThe amount of initiative, judgment, or foresight the person needs to compete in the open marketThe degree of independent business organization and operation. Note This DOL fact sheet on misclassification explains situations in which workers may be misclassified as independent contractors. Some factors aren't important in determining the existence of an employment agreement, including Whether there is a formal employment contractWhere the work is performedWhether the worker is licensedThe time or method of payment State Tests for Independent Contractor Status Each state has its own way to evaluate the status of workers for state wages, hours, and working condition requirements. Several states are now using what's called a three-factor ABC test. This test, in brief, requires that all three of these factors must be met for the worker to be considered an independent contractor: The worker is not under the control of the employer for the performance of work.The work must not be within the usual course of the employer's business.The worker must be "customarily engaged" in an independent trade or business that is the same as the work performed for this employer. Getting a Review by the IRS Are you wondering if your workers are classified correctly? You can ask the IRS to review using Form SS-8 to get a determination letter telling you whether your workers are contractors or employees. You may also apply to the IRS if you have been classifying workers as contractors in error. This application for "530 relief" allows you to get relief from liability or payment if you have been classifying workers as independent contractors in error. It looks at factors that might be in your favor as good faith efforts to comply with the law. Frequently Asked Questions (FAQs) What is the IRS 20 factor test? The IRS had in the past used a 20-factor test to determine whether a worker was an employee or a contractor. However, the organization has since moved away from that test and now looks at just three broad factors—behavioral control, financial control, and the relationship of the parties. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "Independent Contractor (Self-Employed)or Employee?" IRS. "Topic No. 762 Independent Contractor vs. Employee." U.S. Department of Labor. "Fact Sheet #13: Employment Relationship Under the Fair Labor Standards Act (FLSA)." Department of Labor. "Fact Sheet on Misclassification." California Labor & Workforce Development Agency. "ABC Test." IRS. "Worker Classification – Section 530 Relief."