The construction industry utilizes contractors at a high rate when compared to other industries. It’s not surprising then that employers in this industry are often selected for audits or investigations regarding employment liability.
The Internal Revenue Service (IRS) has grouped the common law factors into three major categories when determining an employer-employee relationship. They are behavioral controls, financial controls, and the overall relationship between both parties. Under these categories, there are factors a federal representative will inquire about to assist in determining worker classification. The following are the significant factors that are considered:
Also, an employee may need prior approval from the employing unit to provide similar services to other entities.
A contractor also has recurring business expenses, such as rent expense, overhead, and payroll expense which puts them in a position to realize a profit or loss.
A Contractor is responsible for all incurred expenses when performing the service(s). Whereas an employee is generally reimbursed for out-of-pocket expenses with proper receipt or is issued a company credit card but still provides copies of receipts to the employer.
By advertising his/her services, either through business cards, flyers, company website, newspaper ads, etc., the contractor is being active in soliciting additional work for their entity which is an indicator of being independent.
Other factors to consider in addition to the significant factors noted above are the following:
An individual who receives paid time-off, who is covered under the employing unit’s liability insurance, receives periodic pay raises or bonuses, and other similar benefits will generally be classified as an employee. A contractor is not given the opportunity to participate in or offered such benefits because, once again, they are responsible for all operating costs.
Example 1: An individual who personally performs contractor services as a Dental Assistant at a dentist office, uses company equipment to perform the service, has no control over the rate of pay, and has no discretion over what work to accept or deny, would be determined to be an employee.
Example 2: A Plumber fixing an overflowing toilet at a dentist office and who uses his own tools, controls the time when the repair will happen, sets his own rates, and decides the best way to fix the problem, would be properly classified a contractor.
Moreover, Dentistry and Plumbing are two distinct industries.
An employee does not have to perform services on a full-time or part-time basis. An employee can perform services on a temporary, seasonal, or even on an as needed basis; depending on the employing unit’s industry and operations.
Stating to an individual that he or she will receive Form 1099 for services rendered is generally not sufficient for independent contractor classification. Thus, the three categories mentioned above should be noted by business owners and human resources personnel when searching for contractors and/or employees.
With regard to Arizona Employment Security Law, the employer-employee relationship is codified under Arizona Revised Statutes (A.R.S.) § 23-613.01 and the Arizona Administrative Code (A.A.C.) R6-3-1723. The factors listed under the code are grouped into two categories: control, under (D) (2) (a) through (l); and independence, under (E) (1) through (6). In addition, other factors not listed under (D) or (E) may also be considered under Subsection (F) in determining whether the employer exercised sufficient control over the worker’s services to constitute employment.
It should be noted that the factors largely mirror the IRS common law factors and, therefore, the analysis of whether a worker is an independent contractor or employee is similar.
Fredy Hernandez is an experienced field auditor formerly with the State of Arizona – DES Unemployment Insurance Tax and now works as a financial and tax accountant at Morrison, Clark & Company CPAs, Chandler, Arizona. For more information, call (480) 424-7855 or visit morrisonclarkcompany.com.
This work is also published as Hernandez, F., Employee vs. Contractor: What is the correct worker classification? Construction Accounting and Taxation 28, no. 5 (2018).