The second area of the IRS common law test looks for evidence of financial control—that is, whether the hiring firm has the right to control how the worker conducts business. The factors that usually need to be explored are whether the worker:
- has a significant investment in equipment or facilities
- is not reimbursed for expenses
- makes his or her services available to the public
- is paid by the job or by some other method, and
- has an opportunity for profit or loss.
a. Significant investment
Having a significant investment in equipment or facilities is a good indication that a worker is an IC. The IRS has not set any precise dollar amounts on what constitutes a significant investment. It says only that the investment must have substance.
An IC doesn’t necessarily have to purchase costly equipment to have a significant investment—he or she may rent or lease it instead of buying it. Indeed, an IC can even lease equipment from the hiring firm. So long as the worker pays fair rental value, the lease may constitute a significant investment.
EXAMPLE: Charlene is a backhoe operator for the Yippee Distributing Company. Charlene rents a $75,000 backhoe from Yippee for $1,000 per month—its fair rental value—and pays for liability insurance and regular maintenance on the backhoe. This is clearly a significant investment and helps establish that Charlene is an IC.
The IRS recognizes that many ICs do work that does not require large expenditures for equipment. For example, an IC consultant or salesperson may only require a telephone and home office. For this reason, a significant investment in equipment or facilities is not required for IC status.
b. Business expenses
The more expenses a worker has that a hiring firm does not reimburse, the more opportunity for profit or loss exists and the more control the worker has over his or her financial life—all of which strongly indicate IC status. Typical expenses for people who work for themselves include the following:
- rent and utilities
- advertising
- training
- wages of assistants
- licensing and professional dues
- insurance
- postage and delivery
- repairs and maintenance
- supplies
- travel, and
- inventory.
Of course, many ICs have many or all of their expenses reimbursed by their clients. The IRS recognizes this and does not view it as strong evidence of employee status.
IRS auditors are particularly impressed by fixed ongoing costs that a worker incurs regardless of whether work is currently being performed—for example, office rent and salaries for assistants.
c. Making services available to the public
Unlike employees, ICs’ economic prosperity usually depends on their ability to get new business. To do so, ICs often advertise, maintain a visible business location and generally make themselves available for work in the relevant market. Evidence of such things—for example, a copy of a Yellow Pages ad—indicates IC status.
The IRS recognizes that not all ICs need to advertise or make themselves available to new clients, however. For example, many ICs obtain work by word of mouth without the need for advertising. Moreover, an IC who has negotiated a long-term contract may find advertising unnecessary and may be unavailable to work for others for the duration of the contract. For these reasons, the fact that a worker does not advertise, have a visible business location or make himself or herself available to new clients does not necessarily indicate employee status.
d. Method of payment
Paying a worker a flat fee for an entire job is a very strong evidence he or she is an IC, especially if the worker’s expenses are not reimbursed. The worker runs the risk of losing money if the job takes longer or expenses are higher than anticipated. But he or she can also earn a windfall if the work can be done quickly with lower expenses than anticipated. Such an opportunity to earn a profit or suffer a loss is a hallmark of IC status.
Unfortunately, many ICs refuse to be paid by the job. Many insist on hourly, daily or weekly payment. A worker who is compensated in this manner is guaranteed a return for his or her labor and has little risk of loss. This is generally evidence of an employee status.
The IRS does recognize that some ICs—lawyers, for example—are typically paid by the hour instead of a flat fee. It’s still better not to pay an IC an hourly wage, but it seems clear you can get away with it if it’s a common practice in the IC’s line of business.
Paying a worker on a commission basis is a neutral factor.
e. Realization of profit or loss
The IRS believes that the ability to realize a profit or incur a loss is the strongest evidence there is that a worker controls the business aspects of the services he or she renders. All the factors discussed above are relevant in determining whether a worker can earn a profit or suffer a loss. In addition, the IRS considers whether a worker is free to make business decisions that affect profit or loss