Note to Janice: Janice, thanks for calling in to my radio show today. I’m republishing this post so it is easy for you to find. Keep me posted on your progress.


A person you hire to work for you is either an “employee” or an “independent contractor.” Trying to tell employees from independent contractors can be surprisingly difficult. The IRS used to have a 20-Factor Test that you would use to figure out the difference. But, recently they killed the 20 Factor Test and came up with the 3 Part Test, each with 6 subparts. So, it’s much clearer now. Read on for the new test and why this all matters.

Over-Simplified: Employee vs. independent contractor

A worker is an employee if you have the right to control the end result of the person’s efforts plus how, where and when they work to get that end result. A worker is an independent contractor if you have the right to control or direct the end result of the person’s efforts, but not the efforts or the how, where and when they work to get that end result.

Why it matters

There are two big reasons why it matters: (1) you have different rights and responsibilities for employees and independent contractors; and (2) you are liable for cash money if you call someone an independent contractor that you should have called an employee.

1. Your rights and responsibilities change drastically:

For You, the Boss:

If she is an employee

If she is an independent contractor

  • You have to deduct payroll taxes and withholding.
  • You have to get worker’s compensation insurance.
  • You can’t discriminate against them on the basis of sex, race, national origin, religion, sexual orientation, disability or veteran’s status.
  • You are liable for the acts of your employees.
  • You have to withhold income tax from the employee on payday.
  • You may have to provide health insurance under health care reform.
  • Communications with her about inventions do not start the clock running on the maximum to file a patent application.
  • Every copyrightable work she makes connected to her job belongs to you.
  • She pays her own payroll tax and Social Security and Medicare withholding.
  • You may not have to get her workers’ compensation insurance. But, without worker’s compensation, she could sue you for damages she suffers without the liability limitations built into worker’s compensation insurance.
  • Discrimination laws may not apply to her.
  • She may be excluded from your obligation to provide health insurance in 2014 under Health Care Reform. She also won’t count under the 50-employee threshold for employers who have to provide health insurance.
  • Disclosures about inventions probably need a special confidentiality agreement to not start the patent application filing.
  • Nothing she makes connected to her job belongs to you, unless you get it in writing.

For the Worker

If she is an employee

If she is an independent contractor

  • Withholding taken care of; she also only pays half of payroll tax that she would pay as an independent contractor.
  • Gets unemployment benefits.
  • Gets worker’s compensation.
  • Ability to deduct business expenses very limited.
  • Protected by lots of laws, like wage and hour, antidiscrimination and laws about indemnification by employer.
  • She is probably not liable for accidentally stupid things she does while at work. But, she could be liable for intentionally stupid things she does while at work.
  • She can deduct business expenses directly.
  • No unemployment benefits.
  • Maybe no Worker’s Compensation (but if so, fewer limits on the boss’s potential liability).
  • Pays self employment tax (which includes full amount of Social Security and Medicare.
  • Must sue to collect any unpaid wages/compensation.
  • Can be sued by third parties for harm caused while working for the boss.
  • Can set up self-employed retirement plans

2. You owe money to the IRS If you should have treated your worker as an employee

If you treat an employee as an independent contractor, you are liable for FICA if the employee doesn’t pay it herself. Plus you are liable for the amount you should have withheld for income taxes if she doesn’t pay. The person who had control over the decision about whether to treat the worker as an employee or independent contractor is on the hook personally for this money. (BTW, there are ways to reduce or erase your tax liability if you made good faith decisions and filed your taxes on time. Talk to your employment lawyer or accountant.)

Is she an employee or an independent contractor?

The IRS’ new 3 part test

An employee is someone exclusive to you who does the work the way you say it should be done. An independent contractor is someone who works for you and other people and does your work the way she wants to do it. The IRS says you can tell the difference between an employee and independent contractor by looking at (1) behavioral control; (2) financial control; and (3) the factual clues that reveal the real relationship.

1. Behavioral control

If you have behavioral control over the worker, then the IRS thinks you are the employer. Behavioral control means the right to control the moment to moment and day to day work performed to get the job done. So, these questions are designed to tease out who gets to pick the process, time and location of work. There are two parts: (a) Instructions; and (b) Training.

  • Instructions. If you provide instructions on the actual how-to over the job, then you look like an employer. Ask yourself if you kept control over: When to work, Where to work, What tools or equipment to use, What sub-workers to hire to assist, Where to get supplies or services, Work that must be done by certain peopleWhat order or sequence of action steps to follow.
  • Training. If you train a worker on how to do something, the IRS thinks you look like an employer. After all, independent contractors ought to have their own methods.  Ask yourself if you provide training on how to get the job done – if you do, you are tipping towards employment.

2. Financial control

If you have control over financial decisions, then the IRS thinks you look like an employer. Financial control is about who bears the financial burdens and possible benefits.

  • Significant investment. Significant investment in a venture is evidence that the independent contractor is a stand-alone business.
  • Unreimbursed business expenses. Stand-alone businesses bear their own expenses. Fixed ongoing costs incurred, whether work is done or not, are a sign that the worker is an independent contractor. But, if you reimburse the worker for all incurred expenses, you look like an employer.
  • On the market. Independent contractors work for many clients; employees work for just one company. If the worker markets her services to others, she is free to seek out other opportunities, she advertises and has a visible business, she looks like an independent contractor.
  • Compensation Structure. The IRS thinks that independent contractors get paid on a project or flat fee basis and employees get guaranteed amounts in a period of time. Therefore, paying the worker a total amount for a period of time looks like an employment relationship.
  • Profit. Independent contractors have the opportunity to make a profit on work; employees get paid wages. If the worker has a potential to realize a profit or a loss, he is probably an independent contractor.

3. Type of Relationship.

If there are parts of your relationship with your worker that look like employment, then you look like an employer. This is a way of examining the facts in your arrangements to infer a truth.

  • Written Contract. A written contract describing the relationship as an independent contractor relationship is helpful, but doesn’t rule the ending.
  • Employee Benefits. Independent contractors provide their own benefits; employees get them from their employer. If you pay your worker employee-type benefits, like insurance, pension, vacation or sick days, you look like an employer.
  • Permanency. The IRS thinks that companies hire independent contractors to do projects and hire employers to work on a permanent basis. If the engagement goes on indefinitely, rather than for a project or period, you look like an employer. Similarly, the right to fire a worker without penalty makes you look like an employer.
  • Services critical to business. The IRS thinks that the regular business activities of the company are done by employees. If services performed by the worker are a key aspect of the regular business of the company, you look like an employer.

You can also ask the IRS to make the decision for you by filing Form SS-8.

PS: There are these things called “statutory employees” that are employees no matter what. Some work at home workers, drivers, insurance sales people, traveling sales people and realtors are statutory employees (those occupations that filled Tennessee Williams plays). But, talk to an employment lawyer for more.


  • April 7, 2011 Reply

    Law Peterson

    Wow. I finally get it. Thanks for publishing this.

  • April 7, 2011 Reply

    L.C. Seasongood

    Hi. Just read your post. You mean the IRS killed the 20-factor test and replaced it with an 18 factor test? That seems like form over substance (funny lawyer joke). Anyway, thanks for posting this.

  • April 7, 2011 Reply

    John S-S

    You seem to be arguing that the real question is not about control, which is what the IRS says, but about facts that show the independent contractor as its own business (vs employees who are part of their employers’ business). I don’t know that I agree, particularly the reams of caselaw emphasizing control factors. But I think it is an interesting concept.

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