Tests used by the courts to determine whether a person is an employee or independent contractor

Please find below guidelines used to determine whether an individual is an employee or an independent contractor. The following is compiled from an article by Robert Mot, CA, published in the Nov. 1990 edition of CMA Magazine, and an opinion letter of Feb. 19, 1986 provided by KMG Thorne Riddell, Chartered Accountants, for Camosun University.

The determination of whether an individual is an employee or independent contractor depends upon whether or not a "employer-employee" relationship exists between the payer and the payee. Normally an employee is subject to the direct supervision of their employer who controls the manner in which tasks are performed. An independent contractor works independently to achieve a specified result.

There are a number of considerations when evaluating whether an individual is an employee or an independent contractor for income tax purposes, and the courts over the years have developed key tests to assist in determining this. Four of the most significant tests are:

1. Control test

   This test deals with the ability of the company or institution to control the actions of the individual. The distinction to be made is whether a contract between the individual and the University is a contract for service or a contract of service. Revenue Canada's IT 525 states that:

   "A contract of service generally exists if the [University] has the right to control the amount, the nature, and the management of the work to be done and the manner of doing it. A contract for services exists when a person is engaged to achieve a defined objective and is given all the freedom required to attain the desired result."

   In addition to this is the ability, where possible, of the contractor to control the place of work and the ability to delegate items to others.

   The University specifies the courses (and curriculum) to be taught, as well as the times and locations of these courses. In addition to this degree of control is the integration of the courses into the business of the University, and the requirement to co-ordinate all efforts toward the objective of education, according to the standards and policies established for the institution. These factors preclude entering an independent contractor relationship.

2. Economic reality test

   This test deals with the economic practices of the individual. If the individual has ultimate responsibility for the profit or loss of the contract, then this test would indicate a self-employed situation. Where there is financial risk, opportunity to profit or possibility of loss and responsibility for costs, it is inferred that the taxpayer is an independent contractor. On the other hand, where these elements do not exist, there is an inference of employment. The extent to which the individual uses the property of the employer (i.e. classroom, learning resource materials, audio-visual equipment, tools, etc.) in the course of the contract is also considered.

3. Specific results test

   This test deals with the nature of the service provided. If an individual is contracted to achieve a certain objective or result, then the service provided would indicate that the individual is an independent contractor. If, however, the contract is for personal services with no specific objective, the contract would resemble one for employment. In other words, this test looks to whether the alleged employee is required to make their services available on an ongoing basis or whether services are made available to achieve a specified result.

4. Integration test

   This test deals with the individual's degree of involvement in the organization. This test presupposes that if the services provided by an individual are integral to the organization, then their involvement is one of employee. If the services can be viewed as part of a separate business of the individual who provides the services, the individual may then be viewed as an independent contractor. The courts have tended to downplay this test, however, on the basis that businesses can be mutually dependent on each other without a "master-servant" relationship.

No one factor determines whether an individual is an employee or an individual contractor. Revenue Canada and the courts look to the facts in each situation when assessing. The following "Test on Employment Status," taken from the NACUBO Business Officer, August 1992, may also assist with the determination of whether an individual is an employee or an independent contractor.

Source: NACUBO Business Officer, August 1992

Still not sure about employee or self-employed status? Check out http://www.cra-arc.gc.ca/E/pub/tg/rc4110/rc4110-e.html for additional help.

The Common-Law Test is a set of guidelines used by the IRS that classifies workers as either employees or independent contractors. 

The test measures how much behavioral and financial control an employer has over an individual and the type of relationship both parties share. A worker who meets the guidelines of the Common-Law Test is considered to be an "employee.”

Employee vs. Independent Contractor

Though a business can hire and pay both employees and independent contractors, there are important legal differences between the two: 

• Employees get income tax, Social Security, and Medicare withheld from their paychecks. They may be entitled to the protections of employment and labor laws. 

• Independent contractors do not get taxes withheld. They are also not entitled to standards and rights laid out in employment and labor laws. 

What Are the 3 Factors in the IRS Common-Law Test?

There are three key factors in the Common-Law Test that determine whether a worker is an employee: 

1. Behavioral Control

Are there facts that illustrate an employer’s right to direct or control how the worker should conduct their work? 

According to the IRS guidelines, four components determine behavioral control: 

• Types of instructions given: If a business gives instructions on how, when, and where a worker should perform their work (what tools/equipment to use, what specific work must be done, what order/sequence the work must follow, etc.), the individual is likely an employee. 

• Amount of instructions: The more detailed the instructions, the more control a business has over the worker. Therefore, a large degree of instructions would imply the individual is an employee. 

• Evaluation system: If there is an evaluation system that measures work performance, this would specify the worker is an employee. But if the evaluation simply judges the end result, they can either be an employee or an independent contractor.

• Training: If the business trains the worker on how to do their job, this indicates an individual is an employee (the business wants the job done a particular way). An independent contractor is free to execute their job duties using their own process.

2. Financial Control

Does the business have control over the financial aspects of the worker’s job? The more financial control it has, the more likely it is that the worker is an employee rather than an independent contractor. 

There are five financial control factors that determine a worker’s classification:

• Significant investment: Though there are no specific dollar amounts a worker must meet to signify they are making a “significant investment,” independent contractors generally invest a lot more in the tools/resources they use than employees do.

• Unreimbursed expenses: The extent to which workers incur unreimbursed expenses can indicate whether they are an employee or independent contractor. Independent contractors are likely to have more unreimbursed expenses than employees. But businesses should be careful not to base their decision on this factor, as employees can also incur unreimbursed expenses. 

• Opportunity for profit or loss: The more profit a worker makes, the more likely it is that they are an employee. And the more losses they incur, the more likely it is that they are an independent contractor. 

Say a worker invests quite a bit into their tools/resources and incurs unreimbursed expenses. They would have a greater possibility of incurring losses rather than profit. This would indicate they are an independent contractor. 

• Services available to the market: Independent contractors are free to seek out business opportunities. They usually have their services advertised in the market to stay in business. Employees generally need to refer to their company policy on operating a side business and may need to discuss this with their employer. 

• Method of payment: Independent contractors are usually paid a flat fee for the job or paid on an hourly basis. Employees are generally guaranteed a wage or salary amount for a period of time. Even when someone’s wage/salary is supplemented by a commission, they would still be considered an employee. 

3. Type of Relationship 

What kind of relationship exists between the business and worker? There are four categories to consider to help classify your worker: 

• Written contracts: The contract should state how both parties—the business and the worker—work together. This determines the worker’s status. A contract stating whether someone is an employee or independent contractor is not adequate enough to determine a worker’s classification. 

• Employee benefits: Benefits like health insurance, paid time off (PTO), and sick days are generally offered to employees but not independent contractors. 

• Permanency of the relationship: Employees are often hired for an indefinite period of time, while independent contractors are usually hired for a specific time period or project.

• Services provided: A worker who offers services that are central to the business is more likely under the direct control of the company. This would, therefore, indicate an employer-employee relationship. 

What Are Right-to-Control Tests?

Common-Law Tests are also commonly called the Right-to-Control Tests. They are collective balancing tests that decipher whether a business has the right to control what the worker does and how they should do their work. 

Why Is Employee Classification Important for Employers?

Employee classification is essential because it affects the taxes and reports businesses and workers submit to federal and state governments. 

For example, employees are generally required to receive a W-2 form and independent contractors are required to receive Form 1099-MISC to file their tax returns. Misclassifying your workers can result in financial penalties from the IRS. 

Moreover, employee classification can determine the kinds of pay and benefits the worker is entitled to. For example, a business might pay employees a salary but pay independent contractors on an hourly or per-project basis.