Understanding Employee Classifications II: Financial Control

Under the letter of the law, the lines between employees and independent contractors have started to blur a bit. New lawsuits are coming down in favor of 1099 contractors who say their employers are working them in ways that are very much the same as a full-time worker. Companies are watching these rulings closely to help them understand whether their workers are contractors or employees based upon the current legal and regulatory environment.  

For now, the legal test for whether your workers are independent contractors or employees rests primarily with the IRS, who has classified work status into three categories. Our last blog explained the IRS Behavioral Control Category. It was the first in a series of three blogs covering IRS rules. This blog will review the Financial Control classification. The final blog will discuss Relationship Factors as defined by the IRS.  

Let’s tackle Financial Control as it pertains to your workforce.  

Employee or Independent Contractor?   

IRS 20-Factor Test: Financial Control  

If a worker is found to be an employee, the employer must pay state unemployment taxes on that worker’s earnings. If an independent contractor, this isn’t the case. For these and other reasons, most employers have a vested interest in making sure they fully understand their workers’ employment designation.  

The IRS says, “Financial Control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job.”  

There are several questions the IRS uses to determine the status of a worker under this category. For example:  

  • Do they receive payments hourly, weekly, or monthly? An employee is usually paid at specific intervals, such as by the hour, weekly, or monthly. An independent contractor is usually paid after the project is met.   
  • How are expenses reimbursed? Independent contractors usually have more unreimbursed expenses. But this is a vague point because many workers also have unreimbursed expenses. It’s complicated, but that is why the IRS looks at all three categories and subcategories when determining if a worker is an independent contractor or employee.  
  • If the company furnishes tools, materials, or other equipment, the IRS suggests this is indicative of an employee/employer relationship. However, this is another vague category because some industries, such as construction, require employees to furnish their own tools.   
  • The significant investment rule says if the worker has a substantial investment in the facilities where the work is performed, the worker is more likely to be an independent contractor.   
  • An employee generally is paid for the time to complete the required work and has no liability for business expenses associated with completing the work. However, an independent contractor can generally make a profit or suffer a loss as a result of performing the service.   

There are all kinds of lawsuits pending from the misclassification of workers. The company benefits by classifying the worker as an independent contractor by saving thousands on overtime, vacation and sick time, and unemployment, among other things. When a worker is misclassified, they can sue, seeking damages.  

These are all good reasons to work with an experienced employer of record who can clarify the employer/worker relationship and help you handle the tricky and ever-changing regulatory rules around employment categories. Talk with our team today.