So, you’re ready to hire some help but you’re not sure whether an independent contractor or employee is the right fit for your online business. Whether you’re looking to hire a Virtual Assistant, Copywriter, Bookkeeper, or an individual in some other niche, you need to know what “independent contractor” means before you even start your search.
Why? Because you can be penalized if you get it wrong. And no one wants to end up owing penalties and fines!
It’s important to note that different government agencies apply different definitions of “employee” and “independent contractor” – and to make things even more complicated they use different tests to determine whether a service provider is an employee or an independent contractor. In this blog post I am going to cover the Internal Revenue Service (IRS)’s test for federal income tax purposes as well as the test California’s Employment Development Department (EDD) uses for unemployment and disability insurance and the Division of Labor Standards Enforcement uses for wage and hour claims.
Everything I chat about here is intended to provide legal information and education. It is not business, financial, or legal advice, and does not create an attorney-client relationship between us. I’m an attorney licensed in the United States, so everything will be from the perspective of United States law. You should consult with an attorney in your area who understands your particular business situation so that you can take the right steps for you and your business.
Is an independent contractor an employee?
The short answer is no.
The biggest difference between employees and independent contractors is how they are taxed and the IRS plays a huge role in that determination.
Employees receive a W2 from their employers, who are obligated to pay one-half (½) of the employees’ FICA taxes (Social Security and Medicare) as well as unemployment taxes.
Independent contractors, on the other hand, receive a 1099 from the companies they work with and are required to pay 100% of their own self-employment and income taxes.
Since the IRS has such a huge interest in whether people are classified as either an employee or independent contractor (hello tax collector), it created a test to make the determination.
What is the IRS independent contractor test?
The IRS’s 20-part “right to control test” determines whether someone is an employee or an independent contractor. The distinction is incredibly fact specific and made on a case-by-case basis.
- Level of Instruction – Do you control when, how, and where the work is to be done by your worker?
- Amount of Training – Do you provide training for your worker?
- Degree of Business Integration – Do your worker’s services significantly affect your company’s success?
- Extent of Personal Services – Do you require your worker to complete the services personally or can she subcontract assignments to others?
- Control of Assistants – Do you assist in hiring, supervising, or paying your worker’s assistants?
- Continuity of Relationship – Is your relationship with your worker ongoing? Or does it involve multiple sequential projects?
- Flexibility of Schedule – Does your worker have control over the hours she works and the days of the week on which she works?
- Demands for Full-Time Work – Is your worker putting in full-time hours for you?
- Need for On-Site Services – Does your worker perform services on-site or is the work performed elsewhere?
- Sequence of Work – Do you dictate the order in which assignments need to be completed by your worker?
- Requirements for Reports – Do you require your worker to regularly provide you with oral or written status reports?
- Method of Payment – Do you pay your worker hourly/weekly/monthly or on a per project basis?
- Payment of Business or Travel Expenses – Do you reimburse your worker for business or travel expenses?
- Provision of Tools and Materials – Do you provide your worker with equipment, tools, and/or materials to perform her services?
- Investment in Facilities – Do you provide a facility for your worker to perform her services or does the worker maintain her own?
- Realization of Profit and Loss – Does your worker have the chance to receive significant profit or loss through her work?
- Work for Multiple Companies – Does your worker provider services for multiple companies or just yours?
- Availability to the Public – Does your worker make her services available to the general public?
- Control Over Discharge – Is your ability to terminate your worker’s services dictated by a contract?
- Right of Termination – Can your worker terminate her services at will or is her termination dictated by a contract?
So, what do all these factors mean? A person doesn’t have to meet all 20 factors to qualify as either an independent contractor or an employee.
Generally speaking, the more control a business exerts over where, how, when, and by whom work is to be performed, the more likely it is that the IRS will find a worker is an employee and not an independent contractor.
But the IRS test isn’t the only one you need to be aware of. Every state has its own independent contractor test. Some look very similar to the IRS’s and some, like California’s, are different. Surprise, surprise, your state is also motivated because it collects taxes too and supplies things like unemployment insurance and worker’s compensation coverage.
What is California’s independent contractor test?
In 2018, the California Supreme Court discarded the former common law right to control test outlined in S.G. Borello & Sons, Inc. v. Department of Indus. Relations and adopted the ABC test. No matter where your business is located, it’s important to be aware of this fundamental shift because many other states are talking about following suit (and the test already mirrors those in New Jersey and Massachusetts).
The 2018 landmark decision in Dynamex Operations W., Inc. v. Superior Court was codified in AB5, legislation that went into effect in January 2020. AB5 sent shockwaves through the gig economy as it established a presumption that workers are employees unless a business can prove otherwise. And if a business fails to establish any of the following three ABC test factors, a worker is presumed to be an employee:
- That the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- That the worker performs work that is outside the usual course of the hiring entity’s business.
- That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
The B prong of the test has been causing the most widespread issues. In the online space, think of the agency model. For example, a virtual assistant hires other virtual assistants to help with her clients’ work. The newly hired virtual assistant is part of the agency’s usual course of business. Which means she’s probably going to categorized as an employee.
It’s important to understand that the law applies to all workers in California, regardless of where the employer is based (i.e. the law applies where the income is earned).
However, AB5 also provides various exceptions.
The following occupations remain governed by the common law right to control test outlined in Borello:
- Insurance brokers
- Doctors, surgeons, dentists, podiatrists, psychologists, veterinarians
- Private investigators
- Registered securities broker-dealers and financial advisors
- Direct sales representatives (who must not be paid by the hour and have written independent contractor contracts)
Under the common law right to control test outlined in Borello, if the hirer controls the manner and means of accomplishing a desired result then an employer-employee relationship exists. If there is doubt about whether the hirer controls, the following factors are weighed to help in a determination:
- Distinct occupation or business – Does the worker have an established occupation or business?
- Industry custom – Is the type of work typically done without supervision?
- Skill – The skill required to produce the desired result.
- Tools and place of work – Does the worker provide his or her own tools and place of works?
- Length of time of service – Are the services continuing or an isolated event?
- Method of payment – Is payment made by time or completed job?
- Regular business – Is the work part of the hirer’s regular business?
- Intent of the parties – Did the parties believe they were creating an employer-employee relationship? Note that this factor does not carry much weight.
- Principal’s actual exercise of control – Does the hirer have actual control over the manner and means of performing services?
- Benefit to principal – Are the services for the benefit of the hirer’s business or the hirer individually?
Professional Services Exceptions:
The Borello test outlined above also applies to professional services for:
- Human resources
- Graphic design
- Grant writer
- Fine artist
- IRS licensed tax professional
- Payment processing agent
- Photographers or photojournalists (who provided 35 or less submissions to the hirer)
- Freelance writers (who provided 35 or less submissions to the hirer)
However, the hirer must also demonstrate the professional services worker meets ALL of the following 6 criteria:
- Maintains a business location separate from the hirer’s;
- Has a business license and any necessary professional license to practice in their profession;
- Sets or negotiates their own rates;
- Set their own hours aside from the project completion date and reasonable business hours;
- Is customarily engaged in the same type of work performed under contract with the hirer or holds themselves out to potential customers as available to perform the same types of work; and
- Customarily and regularly exercises discretion and judgment in the performance of their services.
Business to Business Exceptions:
The Borello test outlined above also applies to bona fide “business to business” contracting relationships so long as the business service provider:
- Is free from the control and direction of the contracting business in the work’s performance;
- Is providing services directly to the contracting business, not the contracting business’s customers and clients;
- Has a written contract with the contracting business;
- Has any business licenses or business tax registrations in the jurisdiction where the work is performed;
- Maintains a business location separate from the contracting business;
- Is customarily engaged in an independently established business of the same nature as the work performed;
- Contracts with other businesses to provide the same or similar services and maintains clientele without restrictions from the contracting business;
- Advertises and holds itself out to the public as providing the same or similar services;
- Provides its own tools, vehicles, and equipment to perform its services;
- Negotiates its own rates;
- Sets its own hours and work location; and
- Is not performing work that requires a license from the Contractor’s State License Board.
What if I get it wrong?
It is critical to make sure that you’re categorizing your workers correctly. If you misclassify someone as an independent contractor when they’re really an employee, the penalties are steep! And they’re even steeper if you do it on purpose.
If you’re really not sure whether the position you intend to offer is for an independent contractor or an employee, you can submit a Form SS-8 to the IRS for a determination. You can read more here. But I highly recommend you speak with an employment attorney in your local area first!
Does a written contract help?
Having a written contract in place with your independent contractors is an important business practice because it helps establish that they really are independent contractors in the eyes of the various government agencies. If you’re not sure where to start, you can snag an Independent Contractor Agreement Template in my Legal Shop.
And for a general overview of the legal issues you should consider for your online business, snag a copy of An Online Entrepreneur’s Guide to Starting a Business.
 S.G. Borello & Sons, Inc. v. Department of Indus. Relations (1989) 48 Cal.3d 341
 Dynamex Operations W., Inc. v. Superior Court (2018) 4 Cal.5th 903