What is the IRS 20-Factor Test?

In these days of the gig economy, more business owners are leveraging the affordability and convenience of hiring freelancers (independent contractors) instead of regular employees. It makes sense. There are some tremendous benefits to hiring independent contractors (ICs), including not having to pay for insurance and payroll taxes. Another huge benefit to hiring ICs is that business owners can’t always predict busy times and downtimes. When seasonal shifts in business necessitate extra help, the business owner can bring on more staff without making any long-term commitments. As business slows down, the owner can simply let the ICs know their help isn’t needed anymore at this time. It seems like a dream come true from an employer standpoint.

However, there are strict IRS rules regarding classification of ICs. If you mistakenly or intentionally classify a worker as an IC when they should be classified as employee, you and/or your business would be held financially liable to the IRS and to the worker. The IRS isn’t setting you up just so they can catch you out. They have established a 20-Factor Test for employers to determine if a worker is classified as an IC or an employee.

What is the IRS 20-Factor Test?

The IRS 20-Factor Test is a self-administered “test” consisting of 20 factors for consideration. Based on the answers to those factors, an employer can more safely determine whether one or more of their workers is classified as an employee or an independent contractor.

The IRS 20-Factor Test Explained

The test is comprised of three general categories; behavioral control, financial control and relationship of the parties. It’s not a cut and dried test as in; this certain number of yes answers means one thing and this certain number of no answers means something else. It’s understood that behavioral control, financial control and relationship of the parties can be vague notions to define. In other words, an employer should do their best to answer truthfully while knowing that the answer can still be ambiguous. Interestingly, the 20-Factor test has been coined the “right to control test” because so many of the factors relate to employer control over the worker. A final note: The IRS doesn’t use this exact 20-Factor test anymore. However, they still use the principles behind it to decide whether or not your workers are employees or ICs. You can effectively use this test to help ensure you’re classifying your workers correctly and in good faith.

1. Amount of instruction

Does the employer dictate when, where and how the worker will complete the work? If so, the worker could be classified as an employee.

2. Amount of training

Is there a minimum number of training hours required before the worker is permitted to begin the job? Is the employer supplying the training? This suggests an employer/employee relationship.

3. Degree of business integration

Is the work heavily integrated with business operations? Is the success of the business heavily reliant on the satisfactory completion of the work by the worker?

This indicates that the worker is an employee rather than an IC.

4. Extent of personal services.

Must the work be performed by a certain person and no one else? ICs are typically free to outsource their work, whereas employees are expected to perform the work themselves.

5. Control of assistants

Does the employee have control over the worker’s assistants? Does the employer dictate who the worker uses as an assistant or even pay the assistant?  This suggests an employer/employee relationship.

6. Continuance of relationship

Has the worker been performing the same job and the same tasks for the same employer for an extended period of time? This could be an employer/employee relationship

7. Control over schedule

Does the employer dictate the hours or days when the work must be performed? This is likely an employer/employee relationship.

8. Demand for full-time work

Does the employer demand that the worker work a minimum number of hours that equates to full-time work? Since this would prohibit the IC from seeking work elsewhere, this would likely be considered an employer/employee relationship.

9. On-site requirements

Does the employer require the worker to perform the job at a certain physical location? Could the work practically be performed elsewhere instead? This is the marking of an employer/employee relationship.

10. Order of work

Is the schedule of the work to be performed dictated by the employer? This indicates a level of control that is more employer/employee than employer/IC

11. Reporting requirements

Does the worker have to check in with employer with status updates on the work being performed? Are written or oral reports a requirement? If so, the worker may be an employee.

12. Method of payment

How is the worker paid? Is there a particular payment schedule set in place, such as hourly, weekly, or monthly? ICs typically get paid in a lump sum once the work is completed

13. Compensation for business or travel expenses

ICs  typically bear their own travel and business expenses, whereas employees are usually entitled to some sort of compensation for business or travel expenses

14. Use of tools and materials

How does the worker get the work done? Is it with company-supplied tools and equipment or are they supposed to provide their own tools and equipment to complete the work? Employees typically use company equipment, whereas ICs are expected to provide their own.

15. Level of investment

ICs do not typically invest in the facilities where they perform work. Does the worker invest in the company premises? If so, they may be an employer rather than an IC.

16. Share in gain or loss

ICs do not share in profit or loss. Employees may be part of a profit-sharing plan.

17. Ability to work elsewhere

Is the worker able to work elsewhere? If not, they may be classified as an employee.

18. Availability to general public

Are the worker’s skills available for general hire to the public? If not, it’s more likely an employer/employee relationship.

19. Control over discharge

What are the circumstances under which the employer can withdraw offers to work? If there is a contract in place, it may or may not suggest in IC relationship with the employer.

20. Right to terminate

Does the worker have the right to turn down ongoing work? If so, that’s more of an IC/employer relationship.

If you hire ICs or a mixture of ICs and employees, go through each of these 20 factors. The answers may surprise you. If you end up just as confused as you when you started, consult with your CPA. They may be able to give you some insight from past experiences with other clients. And if all else fails, you can always contact the IRS for clarification on your particular circumstances.