CONSTRUCTION Accounting ARTICLE -
Beware of the Independent Contractor vs. Employee Dilemma

Target Audience: Construction Industry Professionals, Business Owners, Project Managers, Contractors, Construction Accountants

The independent contractor vs. employee dilemma is one that has affected many industries. The technology sector, for instance, has struggled with it for years because of the long-term, contract-based work done there. Of course, distinguishing between a bona fide employee and a short-term contractual worker is also a natural problem for general contractors, who deal with subcontractors and other specialists regularly.

Drawing the line

Let’s look at an example where the line between independent contractor and employee isn’t clear.

ABC Construction hires Don to provide construction labor for a project. Don signs a statement agreeing that he is a subcontractor, though ABC will pay all construction costs. Don can hire his own helpers but, to assure quality, ABC must approve those workers and will routinely inspect their work. In addition, Don pays the people he hires, but he does so with funds he receives from ABC after he submits a weekly expense statement.

In this scenario, the IRS might recharacterize Don and his helpers as ABC employees — despite the statement Don signed at the project’s beginning. Why? Because in many ways ABC treats them as employees, even though it classifies them as independent contractors and considers them ineligible for employee benefits such as retirement plans or vacation time.

Seeing the IRS perspective

The IRS often uses a 20-factor test to determine whether a worker is an employee or an independent contractor. But the essential question the IRS considers is one of control — three types in particular.

First, there’s behavioral control. Even when the general contractor gives no instructions about how to perform work, if the company has the right to direct how results are achieved, it may have sufficient behavioral control to jeopardize independent contractor status. Along the same lines, general contractors may provide training for actual employees but independent contractors must use their own methods.

Next, the IRS looks at financial control. It considers the extent to which workers have unreimbursed expenses, as well as the extent of a worker’s investment in the facilities used to perform services (the greater the worker’s investment in his or her own business, the more likely it is that the IRS will find independent contractor status). Also important are the extent to which a worker’s services are available to the market, the extent to which the worker can make or lose money and, to some degree, the way in which the worker is paid.

Last in question is relationship control. If a worker provides services that are a key component of the company’s business activities, he or she is more likely to be viewed as an employee. If a relationship is long term, rather than temporary, it may be deemed to be an employer-employee relationship. More obviously, if a company provides employee-type benefits, such as sick or vacation pay, a worker is more likely to be seen as an employee.

Let’s look at another example. Acme hires George to do 300 hours of electrical work at $40 per hour, payable in two-week installments of $3,000 over eight weeks. He’ll receive a total of $12,000 regardless of how many hours he actually works, and he can do other jobs for other companies during the two-month period.

Although one of the factors the IRS has used in the past to define an employee is the receipt of payments of regular amounts at set intervals, George is probably an independent contractor because he is working for a limited time on a specific task, will receive a flat fee for his services and is free to accept other assignments.

Avoiding surprises

There are few things worse than getting a nasty tax surprise when the IRS recharacterizes a contractual worker as an employee — and there are legal risks as well. Work with your CPA and attorney to ensure you’re not running undue risks in this area.

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