Oren D. Saltzman
Saltzman & Jablon, LLC
8156 Main Street
Ellicott City, MD 21043
(410) 313-8342

Employers often attempt to claim that workers are independent contractors rather than employees, in the hope that they can save money on payroll taxes and employee benefit costs. Beware of the many pitfalls that can result from what appears to be a simple matter. If the Internal Revenue Service determines that a worker, considered an independent contractor by the employer, is in reality a misclassified employee, the employer may be liable for back payroll taxes, plus any benefits to which the worker would have been entitled if properly classified. Such a redetermination can seriously affect an employer's financial welfare, even to the point of perhaps losing a tax qualified status.

The Internal Revenue Service has promulgated a 20-point test to be used in differentiating between employees and independent contractors. Examples of the criteria include, that if a worker is required to comply with an employer's instructions about when, where and how he or she is to work, the worker is considered an employee of the employer, regardless of the intention of the employer in labeling the employee as an independent contractor. Another example of the criteria states, that training a worker by requiring an experienced employee to work with the worker, corresponding with the worker, requiring the worker to attend meetings, or using other methods, indicates that the employer wants the work to be performed in a certain manner, and thus, the worker will be considered an employee of the employer. See Rev. Rul. 70-630, 1970-2 C.B. 229.

Unfortunately, the 20-point test is riddled with so many counter-examples, exceptions and inconsistencies that it is difficult to consider it a test at all. Certainly there is not bright red line to consider in determining whether an employer's workers are employees or independent contractors. The decision to be made as to how to treat a worker should not be taken lightly.

As noted in an article written by Wendel R. Bird, "Employee/Independent Contractor: Time to Retire the 20-Factor Test", Journal of Asset Protection, Vol.4 No. 4 (March, 1999), after substantial research on the subject, over 90% of the time the IRS finds that workers are employees rather than independent contractors. The reason for such a lopsided result is that for the most part it is much easier for the IRS to collect FICA, Medicare and income tax from employers rather than collecting self-employment tax and income tax from workers.

Even with the obvious bias of the IRS toward employee status, employers prefer to classify workers as independent contractors. Why is that? Simply put, having to report payroll taxes and to pay employee benefits can be costly and complicated. The penalties and cost to administer the reporting system as it now exists can turn into a bad dream. Employers would rather take their chances. An audit may establish a worker to be an employee, but rather than have the up-front expense and headache of having to report to the taxing authorities from day one, some believe it to be worth the chance.

Perhaps it is time for the IRS to revamp the 20 point test in order to come into line with the wishes and reality of today's business environment. It is an archaic survivor of the technological revolution. We no longer consider the work-place as it was once considered. Today the work-place is characterized by tasks performed using a computer terminal and telephone, communication by the internet and compensation in the form of commissions or fees rather than time clocks.

A new test should be developed whereby the determination of whether a worker is an employee or independent contractor would depend solely upon the amount of time the worker devotes to the performance of an employer's work. A worker who devotes all work time to a single business is to be presumed an employee, while a worker who devotes more than 35% of work time to a second business should be presumed to be an independent contractor. Such a test would be easy to administer for the IRS and employers. The entire process, now a web of confusion and intrigue, would turn into a simple red line rule that permits a guaranteed result.

Unfortunately, for the time being we must live with the system as it now exists. Employers must be aware that there are severe consequences in the event they miscatogorize workers as independent contractors. Although it may be easier up-front to consider a worker an independent contractor, on the back end an employer may be doing more harm to himself and his business then it is worth. Take care employers, this is not a simple issue to be decided without considerable thought.