Worker classification impacts both household employers and small business employers. All employers must determine whether an individual is an employee or an independent contractor. The Fair Labor Standards Act and the Internal Revenue Service (IRS) provide two sets of rules that must be considered. Determining whether there is an employer – employee relationship is critical to determining a homeowner or business owner’s responsibility to pay half of the Social Security and Medicare taxes (7.65%) on a worker’s wages, as well as unemployment, worker’s compensation and disability insurance.  If the individual is an employee, the employer may have to pay all of the foregoing, but not if the individual is an independent contractor. An independent contractor is self-employed, and a self-employed individual is responsible for paying the entire 15.3% of Social Security and Medicare taxes without any contribution from an employer. Although half of the self-employment tax paid can be deducted on Form 1040, it puts an additional financial burden on individuals who should be classified as employees but are misclassified as independent contractors. In addition, the employer does not make contributions for unemployment, worker’s compensation or disability insurance; and the misclassified employee will not have access to this coverage if the need should arise.

A contract between the employer and individual stating that the individual is an independent contractor is not the determining factor. The Courts have applied the “Economic Reality” Test, the “Right to Control” Test, or the “Hybrid” Test, which is a combination of the Economic Reality and Right to Control Tests, to determine whether a worker is an employee or an independent contractor.  All of these tests are multi-factor, and no one factor is dispositive. Under the Economic Reality Test, the factors include: (1) the extent to which the work performed is an integral part of the employer’s business; (2) the worker’s opportunity for profit or loss depending on his or her managerial skill; (3) the extent of the relative investments of the employer and the worker; (4) whether the work performed requires special skills and initiative; (5) the permanency of the relationship; and (6) the degree of control exercised or retained by the employer.

Under the Right to Control Test, the factors include: (1) whether the worker must comply with instruction about when, where and how to work; (2) whether training is provided to the worker; (3) whether the business or homeowner is dependent upon the worker’s services; (4) whether the worker must render the services personally; (5) whether the business or homeowner hires, supervises, or pays individuals assisting the worker; (6) whether there is an expectation of a continuing relationship; (7) whether the homeowner or business sets the hours; (8) whether the worker works full-time; (9) whether the worker must perform services on the premises, even though it may not be necessary to complete the task; (10) whether the homeowner or business determines the sequence of work; (11) whether the worker must submit reports; (12) whether the worker is paid hourly, weekly or monthly, rather than by the job; (13) whether the worker is reimbursed for travel expenses; (14) whether the homeowner or business supplies the worker’s tools and materials; (15) whether the worker has made an investment in the business; (16) whether the worker has some risk of loss or opportunity for profit; (17) whether the worker works for a number of other people or businesses; (18) whether the worker makes his or her services available to the general public; (19) whether the homeowner or business has the right to discharge the worker; and (20) whether the worker has the right to terminate his relationship with the homeowner or business.

All of the factors of each test must be considered when analyzing whether an individual is an employee or an independent contractor, and no one factor is weighted more heavily than the others.  These factors apply to homeowners with workers in the home, as well as to business owners with workers in their business establishments. With respect to a household employee, for example a nanny, perhaps he or she could be considered an independent contractor if the household employer didn’t leave any instructions and the only expectation was that care and safety be provided for the child. If the activities, whereabouts and food eaten were left for the nanny to decide, this may help to indicate an independent contractor status. And if the nanny was responsible for finding a substitute in the event of an absence without input from the homeowner and the family was just one of several for which the nanny worked, this may further support the status of an independent contractor.  The nanny would also need his or her own Employer Identification Number (EIN) to further bolster the independent contractor status. For the typical nanny, this is usually not the arrangement and the household employer has a lot of input concerning who cares for the child and what should be done when caring for the child.  With that type of control exercised by the household employer, it is unlikely the nanny will be an independent contractor. A nanny is just one example, but this analysis must be made for other types of household workers and workers within a business.  Nanny Tax Solutions can help homeowners and business owners analyze these factors.  Contact us today if you have a question about your worker’s classification.