Journal of Business and Behavioral Sciences Volume 23, Number 1 issn 1946-8113 Spring 2011 inthis issue

For most businesses, it is easy to determine which classification workers fall into. In many organizations, all of the workers are classified as employees, while in some industries it is common practice for all workers to be classified as independent contractors. Some organizations can even have both employees and

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An independent contractor is defined as one who is hired to undertake a specific project, but who is left free to do the assigned work and to choose the method for accomplishing it. Unlike an employee, an independent contractor who makes a mistake while carrying out the work does not create a liability for the one who did the hiring (Berson, 2003). Generally, people such as lawyers, contractors, subcontractors, public stenographers, and auctioneers who follow an independent trade, business, or profession in which they offer their services to the public, are considered to be independent contractors. While this is a good rule to follow, the independent contractor classification is actually dependent on the characteristics of each situation, the most important being the individual that has control. If the person that the service is being performed for has the right to control or direct only the result of the work and not the means and methods of accomplishing the result, then the worker is an independent contractor.

§3121(d)(1) any officer of a corporation or

§3121(d)(2) any individual who, under the usual common law rules applicable in determining the employer/employee relationship, has the status of an employee or

§3121(d)(3) any other individual who performs services for remuneration for any person

(A) as an agent-driver or commission-driver engaged in
distributing meat products, bakery products, beverages (other than milk),
or laundry or dry cleaning services, for his principal;

(B) as a full-time life insurance salesman whose principal

3. 
   as an individual that performs services as a home worker performing work, according to specifications furnished by the person for whom the services are performed, on materials or goods furnished by such person which are required to be returned to such person or a person designated by him;
   
4. 
   as a full-time traveling or city salesperson, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations;
   

Journal of Business and Behavioral Sciences

If the contract of services indicates that substantially all of the services are to be performed personally by the person; except that an individual shall not be included in the term ―employee‖ under these provisions if the individual has a substantial investment in facilities, other than those used for transportation, used in connection with the performance of the services, or if the services are in the nature of a single transaction and are not part of a continuing relationship with the person for whom the services are performed; or

§3121(d)(4) any individual who performs services that are included under an agreement entered into pursuant to section 218 of the Social Security Act.

If a worker is an independent contractor under common law rules, but falls into categories A-D above, the worker may nevertheless be categorized as a statutory employee, for purposes of withholding employment taxes. Once a worker is classified as a statutory employee, the employer is required to withhold and pay FICA taxes on the taxable compensation earned by these individuals. Also, if the worker falls into category A or D above, he/she is considered an employee for FUTA purposes and becomes subject to the FUTA tax.

COMMON LAW EMPLOYEES

The good news is that most workers do not fall into the statutory employee category and the common law rules apply. Revenue Ruling 87-41 highlights 20-factors that the courts have used to determine whether or not an individual is a common law employee. The presence of any of these factors may indicate that a worker should be classified as a common law employee. The factors include:

1. Instructions. If the worker is required to comply with the instructions
of the person for whom the work is being performed with regard to the
when, where, and how the work is to be completed.

2. Training. If the worker is provided training by an experienced

3. Integration. If the worker‘s services are being integrated into the

4. Services Rendered Personally. If substantially all of the services must

5. Hiring, Supervising, and Paying Assistants. If the person for whom

6. Continuing Relationship. If there is a continuing relationship between

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7. 
   Set Hours of Work. If the workers hours of work are determined by the person for whom the services are performed.
   
8. 
   Full Time Required. If the worker is required to devote substantially full time to the person for who services are performed.
   
9. 
   Doing Work on Employer‘s Premises. If the services are performed on the premises of the person for whom the services are being performed, especially if the services could be performed elsewhere.
   

10. 
    Order or Sequence Set. If the worker is not free to set the order or sequence in which the work is to be performed.
    
11. 
    Oral or Written Reports. If the worker is required to submit regular reports to the person for whom the services are performed.
    
12. 
    Payment by Hour, Week, Month. If the worker is paid according to the hours, weeks, or moths worked.
    
13. 
    Payment of Business and/or Traveling Expenses. If the person for whom the services are being performed pays the worker‘s business/travel expenses.
    

14. 
    Furnishing of Tools and Materials. If the person for whom the services are being performed furnishes tools and materials to complete the work.
    
15. 
    Significant Investment. If the worker does not have significant investments in facilities/equipment used to perform the work (other than those used for transportation).
    
16. 
    Realization of Profit or Loss. If the worker is not free to realize either a profit or loss as a result of the work performed.
    
17. 
    Working for More than One Firm at a Time. If the worker is not working for more than one firm at one time.
    

18. 
    Making Service Available to General Public. If the worker does not make his services available to the general public on a regular basis.
    
19. 
    Right to Discharge. If the person for whom the services are being performed has the right to discharge the worker.
    

Using these factors as a guide, can in most cases, provide valuable insight into whether a worker is an employee or not. When determining whether or not a worker is an employee, it is important to examine all of the facts of the situation and not to rely on a single classification factor. When examining these factors in relationship to the case at hand, it is also important to remember that the substance of the relationship or situation is more important than the form of the relationship. A relationship contrived to circumvent the employee/employer relationship, will nevertheless still be viewed as such by the IRS.

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In order to better understand the proper classification of workers, the following section of this paper will present three recent court cases involving disputes regarding employee/independent contractor classification. The cases will point out that there is no one criteria that can be relied upon, as you will see, it is important to look at the facts of each situation independently.

Under the lease agreement, Ren-Lyn was paid a percentage of the gross weekly receipts of the lessee. The percentage of gross receipts that the lessee would retain varied from 50 to 65 percent. All receipts were accounted for by Ren-Lyn. The lessee was required to provide all personal equipment and supplies. Ren-Lyn would provide all chemicals, solutions, and dyes at the lessee‘s expense. The employee cosmetologist and the independent contractor cosmetologist performed essentially the same duties of shampooing, hair cutting, hair coloring, sanitizing tools, cleanup and answering the phones. All appointments were made by Ren-Lyn‘s receptionist and all customers paid Ren-Lyn‘s advertised prices. Are the chair lease workers independent contractors or employees?

Court findings:

1. 
   Control of Manner and Means – Although Ren-Lyn trained the workers prior to their becoming independent contractors; it is evident that they had very little control. Once the workers became independent contractors, they had control over the manner and means of providing services. This factor supports independent contractor status.
   
2. 
   Skill – The work was skilled thus supporting independent contractor status.
   
3. 
   Source of Instrumentalities and Tools – The major items such as chair and basin were provided by Ren-Lyn. The tools provided by the independent contractors resulted in an insignificant investment. There was no potential for loss of investment. This factor favors an employee relationship.
   

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4. 
   Location of Work - Services were performed on Ren-Lyn‘s premises. Although the workers could work elsewhere, they rarely did. This factor favors an employee relationship.
   
5. 
   Duration of the Relationship - The independent contractors worked continuously for Ren-Lyn for many years. This factor favors an employee relationship.
   
6. 
   Workers‘ Discretion Over Working Hours - The independent contractors had control over their hours. They had keys to the shop and were free to come and go as they pleased. This factor favors independent contractor status.
   
7. 
   Method of Payment - The independent contractors were paid by the job. This favors independent contractor status.
   
8. 
   Workers‘ Role in Hiring Assistants - The independent contractors could either use Ren-Lyn‘s assistants or hire their own assistants; Ren-Lyn had no control over this. This factor favors independent contractor status.
   
9. 
   Integration of Business - The independent contractors were a part of Ren-Lyn‘s regular business. This factor favors an employee relationship.
   
10. 
    Principal in Business - Ren-Lyn was in the business of supplying styling services to customers and used the independent contractors to accomplish this end. This factor favors an employee relationship.
    
11. 
    Employee Benefits - The independent contractors did not receive any benefits. This factor favors independent contractor status.
    
12. 
    Tax Treatment and Parties Intent—Ren-Lyn‘s use of 1099‘s and the independent contractor lease agreements clearly specify that the intent was to create an independent contractor relationship. This factor favors independent contractor status.
    
13. 
    Distinct Occupation -- The evidence of state licensure is required for this occupation demonstrates that cosmetologist is a distinct occupation and thus favors independent contractor status.
    

• Compliance with rules, regulations - owner shall have the right to impose such rules and regulations on the use of the premises by performer and owner, in its sole and absolute discretion, shall deem necessary and appropriate. Performer agrees to be bound by and to

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• 
  Status of parties - the parties hereto acknowledge that the status created between owner and performer is that of a lease for the use of the premises. The parties hereto specifically negate any employment relationship. Performers shall be exclusively responsible for and pay all taxes … in connection with any income earned by performer at the premises.
  
• 
  Costumes - performer shall supply her own costumes and … owner shall have no responsibility or liability in connection therewith.
  
• 
  Nature of performance - owner shall have no right to direct or control the nature, content, or means of performer‘s performance.
  
• 
  Other clauses included in the contract relate to the performer‘s scheduling of dates, the payment of ―rent‖ to the owner ($5 per hour or $30 minimum), and the performer‘s obligation to perform during all hours of each shift. The rent was to be paid regardless of the performer‘s income on a particular day.
  

Are the dancers independent contractors or employees?

The government argues the following:

• 
  For federal employment tax purposes, the performers qualify as Rick‘s employees as a matter of law. The government‘s premise is that the plaintiffs control over performers as described in their written contract establishes an employer/employee relationship.
  
• 
  Even if payments to the performers do not come directly from the taxpayer, there is an employer-employee relationship and a constructive receipt of salary. The government‘s basic premise is that if a party is given control over the details of how the work is done, it is an employer.
  
• 
  The government also insists that every case adjudicating the classification of dancers has concluded that they were employees.
  

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The court‘s response:

• 
  The court concludes that there is an ambiguity precluding a decision that the performers are employees. Even if the government is correct that the contract indicates Rick‘s right of absolute control, there remain issues of fact as to whether performers receive some remuneration from the taxpayer.
  
• 
  With respect to the rents paid, Rick‘s chips, 50% split on ladies drinks, the court could not determine as a matter of law that Rick‘s does or does not pay some wages to or employ the performers in some capacity.
  
• 
  The court did conclude, as a matter of law, that the payments to the performers from customers are not subject to employment taxes for the period in question.
  

Through the telephone line, the performer and the patron negotiate the content of and the price of the performance, as well as communicate during the performance. The patron pays the performer for the requested performance by passing money through a slot in the booth. The performer retains the entire performance fee paid by the patron; however, the same is not true for the token box receipts. Written agreements between the performers and Show World for use of the booths are executed daily indicating that 60% of the token box receipts goes to Show World and 40% of the token box receipts goes to the performer. Show World retains the performer‘s share of the token box receipts from her first

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The IRS conducted an on-site examination on Show World‘s fantasy booth operation and concluded that the performers were Show World employees. The IRS then sent a letter and examination report to Show World proposing deficiencies for unpaid employment taxes.

Are the performers in the ―One-on-One fantasy booths‖ independent contractors or employees?

Court findings:

1. 
   Instructions – Show World exercises considerable control over the performers and monitors the booths by audio in order to ensure compliance with its instructions. This factor lends support to employee classification.
   
2. 
   Training – Although little formal training is needed, Show World trains its new booth performers by allowing them to observe the performances of others. This factor lends support to employee classification.
   
3. 
   Integration – Between 15-30% of Show World‘s gross revenue is made up of the token box receipts, therefore the performance of these entertainers effects Show World‘s continued viability in adult entertainment. This factor lends support to employee classification.
   
4. 
   Services Rendered Personally – Show World prohibits booth performers from hiring their own substitutes to work their shift giving the performers lack of control. This factor lends support to employee classification.
   
5. 
   Continuing Relationship – Booth performers typically work for a single establishment for a short period of time and will work for several operators in a given period of time. This factor lends support to independent contractor classification.
   
6. 
   Hours of Work – Performers are allowed to pick one of two shifts, bus must work throughout the entire shift and must remain on the premises in order to receive compensation. Show World‘s control over the hours of work performed by their booth performers favors employee classification.
   
7. 
   Full-Time – Show World‘s performers do not perform on a full time basis. This factor lends support to independent contractor classification.
   
8. 
   Place of Work – Booth performers are required to work on the premises of Show World and must perform their work on the premises in the
   

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individual booth and may not leave the premises mid-shift if they wish to be compensated. This factor lends support to employee classification.

9. 
   Method of Payment – The payment by a firm of regular amounts (40%) at stated intervals to a worker strongly indicates an employer-employee relationship.
   
10. 
    Business Expenses – The bulk of business expenses incurred in running one-on-one booths (electricity, security, maintenance) are paid by Show World, again lending support to an employer-employee relationship.
    
11. 
    Investment – Show World maintains the facilities, renovates when necessary, and advertises. This factor lends support to employee classification.
    
12. 
    Realization of Profit or Loss – The booth performer has a limited ability to realize profit and has almost no financial down-side. This factor lends support to employee classification.
    
13. 
    Working for More than One Firm at a Time – Booth performers are free to work at other adult entertainment operations and do in fact work in other location. This factor lends support to independent contractor classification.
    
14. 
    Right to Discharge the Worker – Show World has control over whom it permits in its booths; therefore, it has the power to discharge any worker who does not follow its guidelines. This factor lends support to employee classification.
    
15. 
    Right to Quit – Booth performers have the freedom to leave without incurring liability beyond the 40%, lending support to employee classification.