Carnegie Mellon University

Independent Contractors vs. Employees

Independent contractors are individuals such as lawyers, contractors, subcontractors and others who follow an independent trade, business or profession in which they offer their services to the public.

How to Determine Independent Contractor vs. Employee

To determine whether an individual is an employee or an independent contractor under the IRS regulations, the relationship of the individual and the business must be examined. All information that provides evidence of the degree of control and the degree of independence must be considered.

CMU must weigh all the factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the work is an employee, while other factors indicate that the worker is an independent contractor. There is no formula for which factors make the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. Facts that provide evidence of the degree of control and independence fall into the following three categories:

All the necessary steps for determining and procuring the services of an independent contractor should be completed before any services are performed. Misclassification of a service provider can result in taxes, interest and penalties. For assistance in evaluating independent contractor status, contact Taxation for assistance.

Degree of Control and Independence Categories

Behavioral Control

Facts that show whether CMU has the right to direct and control how the worker does the task for which the worker is being hired. A worker is an employee when CMU has the right to direct and control the worker. CMU does not have to actually direct or control the way the work is done – as long as CMU has the right to direct and control the work itself. The behavioral control factors fall into the categories of:

  • Types of Instructions Given: An employee is generally subject to CMUs instructions about when, where, and how to work; what tools/equipment to use; what workers to hire or assist with the work; where to purchase supplies/services; what work must be performed by a specified individual and what order or sequence to follow when performing the work.
  • Degree of Instruction: This means the more detailed the instructions, the more control CMU exercises over the worker indicating that the worker is an employee.  Less detailed instructions reflect less control indicating that the worker is more likely an independent contractor.
  • Evaluation Systems: If an evaluation system measures the details of how the work is performed, then these factors would point to an employee. If an evaluations system measures just the end result, then this can point to either an independent contractor or employee.
  • Training: If CMU provides training on how to do the job, this indicates that CMU wants the job done in a particular way and represents strong evidence that the worker is an employee. Periodic or on-going training about procedures and methods is even stronger evidence of an employer-employee relationship; however, independent contractors ordinarily use their own methods.

Financial Control

Refers to the facts that show whether or not the business has the right to control the economic aspects of the worker’s job.  The financial control factors fall into the categories of:

  • Significant Investment: An independent contractor often has a significant investment in the equipment he/she uses in working for someone else.
  • Unreimbursed Expenses: Independent contractors are more likely to have unreimbursed expenses than are employees.
  • Opportunity for Profit/Loss: If a worker has significant investment in the tools and equipment and has unreimbursed expenses, the worker has a greater opportunity to lose money. Having the possibility of incurring a loss indicates that the worker is an independent contractor.
  • Services Available to the Market: An independent contractor is generally free to seek out business opportunities. They often advertise, maintain a visible business location and are available to work in the relevant market.
  • Method of Payment: An employee is generally guaranteed a regular wage for an hourly, weekly or other period of time. An independent contractor is usually paid by a flat fee for the job; however, in some professions it is common to pay independent contractors hourly.

Type of Relationship

Refers to the facts that show how the worker and CMU perceive their relationship to each other. The factors, for the type of relationship between two parties, generally fall into the categories of:

  • Written Contracts: Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status. How the parties work together determines whether the worker is an employee or independent contractor.
  • Employee Benefits: These include things like insurance, pension plans, paid vacation, sick days and disability insurance. Businesses generally do not grant these benefits to independent contractors. However, lack of these types of benefits does not necessarily mean the worker is an independent contractor.
  • Permanency of the Relationship: If a worker is hired with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the intent was to create an employer-employee relationship.
  • Services Provided as Key Activity of the Business: If a worker provides services that are a key aspect of the business (i.e. teaching services at CMU), it is more likely that the business will have the right to direct and control his/her activities.