The 20-factor test is used as an aid by the IRS to determine whether an employment relationship exists between the individual and the firm under common law rules, for federal employment tax purposes. The factors are applied to the given factual situations to determine whether the individual is an employee of the firm for such purposes.
These factors have been developed based on an examination of cases and rulings considering whether an individual is an employee. As Edward E. Lenz highlights in his book Co-Employment, “the degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed.”
Because the 20 factors are designed only as guides, and special scrutiny is required in applying them.
The 20 factors
- Instructions. “A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee.” This control is present if the company for which the services are rendered has the right to require compliance with instructions.
- Training. Training the worker by requiring another employee to work with him, by corresponding with him, by requiring meeting attendance, or using other methods, indicates the company wants the services to be performed in a particular method or manner.
- Integration. High integration of the worker’s services to the company’s operations generally shows that he is subject to control and direction. “When success or continuation of business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business.”
- Services rendered personally. If services must be rendered personally, presumably the company is interested in the methods used to accomplish the work as well as in the results.
- Hiring, supervising, and paying assistants. If the company hires, supervises, and pays assistants, that factor generally shows control over the workers on the job.
- Continuing leadership. A continuing relationship may exist if work is performed “at frequently recurring although irregular intervals.” A continuing relationship indicates that an employer-employee relationship exists.
- Set hours of work. Establishment of set hours of work by the company is a factor that indicates control.
- Full time required. If the worker must devote substantially full time to the business of the company for which services are performed, then the company has control over the amount of time the worker spends working and this implies a restriction over the worker from doing other gainful work.
- Doing work on employer’s premises. If the work is performed on the premises of the company for which services are rendered, this suggests control over the worker, especially if the work could be done elsewhere. Working on or off premises is not a fact that stands by itself, since the importance of this factor depends on the nature of the service and the extent to which an employer generally would require that other employees perform the same services on the company’s premises. Control over work can be more easily identified when the company has the right to compel the worker “to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required.”
- Order or sequence set. If worker must perform in the order or sequence set by the company, this shows control as the worker is not free to follow his own pattern of work with varying routines and schedules. It is sufficient to show control if the company retains the right to set the order of the services, even if it never does or does infrequently.
- Oral or written reports. If the worker is required to submit regular oral or written reports to the company, this indicates control.
- Payment by hour, week, month. “Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job.”
- Payment of business and/or traveling expenses. If the company generally absorbs the costs of business and/or traveling of the worker, then the worker is ordinarily an employee.
- Furnishing of tools and materials. If the company furnishes significant tools, materials, and other equipment, this tends to show the existence of an employer-employee relationship.
- Significant investment. If the worker doesn’t invest in facilities for himself used for performing services, it might signal the dependence on the company for whom services are performed, and accordingly, the existence of an employer-employee relationship. Special scrutiny is required in this matter, especially in respect to certain types of facilities such as home offices.
- Realization of profit or loss. An independent contractor can realize a profit or suffer a loss as a result of his own services; but if the worker cannot, then he is generally an employee.
- Working for more than one firm at a time. “If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.” However, it could be the case that the worker is an employee of each of these firms, especially if the firms are part of the same service arrangement.
- Making services available to general public. If the worker makes his or her services available to the general public on a regular and consistent basis, it is an indication that he is working as an independent contractor.
- Right to discharge. “The right to discharge a worker is a factor indicating that the worker is an employee.” An employer has control through the threat of dismissal, and this causes the worker to obey the employer’s instructions. On the other hand, an independent contractor cannot be fired so long as he produces a result that meets the contract specifications.
- Right to terminate. If the worker holds the right to end the relationship with the company at any time without incurring liability, it is an indication of an employer-employee relationship.
It is critical for organizations to understand that control is the main element to assert whether a contractor is or isn’t considered an employee by the law. An independent contractor should work as such, and all circumstances of the arrangement must be respected in order for the worker to be considered a contractor under law.
Many companies seek to avoid the employer-employee relationship for tax purposes, but in the end this decision holds them liable for employee misclassification and penalties can exceed that of the taxes that would be paid otherwise.
It is a matter of taking smart decisions and abiding by the rules, especially under co-employment agreements where there are other parties involved as well.