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Independent Contractor and Employee Overview

Summary: This page describes the following concepts:

• whether you should hire someone as an independent contractor or an employee
• the IRS definition of independent contractor
• the IRS definition of employee
• the difference between personal services, professional services, consulting services

Independent contractors and employees all furnish services to UCSC.

The characterization of individuals as independent contractors or employees has important tax and non-tax consequences to both the University and the individual. It is generally more advantageous to federal and state government to have an individual classified as an employee. During employment tax audits, the Internal Revenue Service (IRS) will almost always treat individuals as employees, absent a reasonable basis for classification as an independent contractor by the employer. Misclassification of an individual can be very expensive to the University, so it is essential that proper characterization of an individual be determined before any payments are made to that individual for services performed.

Before you hire a person to provide services, determine the type of business relationship that exists between UCSC and the person: independent contractor or employee. IRS and UC policies require that UCSC classify all workers correctly. Misclassification of employees may result in significant penalties.

The first step to classifying a worker is to identify the type of business relationship the university will have with the worker. Will the worker be an Independent Contractor or an Employee of the University. The following two examples, provided by the IRS, can help you determine the business relationship.

Who is an Independent Contractor?
A general rule is that you, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.

Example: Vera Elm, an electrician, submitted a job estimate for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs additional electrical installations under contracts with other companies, that she obtained through advertisements. Vera is an independent contractor.

Who is an Employee?
A general rule is that anyone who performs services for you is your employee if you can control what will be done and how it will be done.

Example: Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works 6 days a week, and is on duty in Bob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob also pays the cost of health insurance and group-term life insurance for Donna. Donna is an employee of Bob Blue.

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Determining the Business Relationship: The Independent Contractor Prehire Worksheet (MS Word) must be completed by the requisitioning department prior to hiring a worker as an independent contractor. Several classification factors serve as guidelines. The process is not black and white and no one factor results in a specific finding. Every piece of information helps determine the extent to which the employer retains the right to control the worker. Consider all of the facts before making a hiring decision.

Hiring Decisions: Departments may make the final recommendation about the business relationship of workers to the University for low-value purchases.

For high-value purchases, a professional buyer in the Purchasing Department makes the final recommendation. However, in cases where it is difficult to determine a worker's correct status using the Independent Contractor Pre-Hire Worksheet, Human Resources will assist in determining whether an employer-employee relationship or an independent contractor relationship exists.

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Personal and Professional Services: Generally, there are two kinds of services provided by independent contractors.

• Personal services are infrequent, technical, or unique functions performed by individuals rather than partnerships, firms or corporations. Examples of such services include technical writing and editing, translation, transcription, drafting, artistic work, and programming. These contractors use their SSN (Social Security Number) for tax purposes.
• Professional services are infrequent, technical, or unique functions performed by independent contractors or consultants whose occupation is the rendering of such services. While not limited to licentiates (individuals holding professional licenses), the services are considered "professional" and the contract may run to partnerships, firms, or corporations as well as to individuals. Examples of professional services contracts include: accountants, appraisers, archaeologists, attorneys, management and systems consultation, architects and engineers, physicians, performing artists, researchers, and real estate brokers. The selection of an independent contractor or consultant providing professional services is usually based on skill, knowledge, reputation, and creativity. Price may be a secondary factor in the selection.

An independent consultant is an independent contractor who provides professional services. Typically, a consultant is an individual of proven professional or technical competence who provides primarily professional or technical advice to the University, but doesn't direct or carry out solutions. As with independent contractors, the University does not control either the manner of performance or the result of the service.
Arrangements may be made to secure the services of an independent consultant when a determination has been made that the:

• Services are so urgent, special, temporary or highly technical - that they cannot be performed economically or satisfactorily by existing University staff during the course of their normal University responsibilities or duties.
• Use of an independent consultant is expected to be infrequent and is primarily used to solve clearly-delineated problems.
• Scope of work will be limited, and the consultant will not be hired to direct or carry out a major portion of a program.

Employees are hired through Human Resources. UCSC controls the work they perform and the way they perform it. See How to Fill a Vacancy.

Dual Status Workers: On rare occasions, the IRS allows an individual teacher or researcher to perform services to UCSC as both an independent contractor and an employee. These services must be separate and distinct, and the requesting department must document this thoroughly.

Need an expert? Contact Nancy Nieblas (831) 459-3858.

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Last revised: January 23, 2007 (am)