Revenue Ruling 79-56: Determining Worker Status

IRS guidance provides a framework for determining if a worker is an employee or an independent contractor. This distinction carries tax consequences for both the business and the worker, and the analysis moves beyond contract labels to examine the reality of the relationship. The primary factor is the degree of control a business exercises over the individual performing services, which serves as the foundation for proper classification.

The Core Principle of Control

At the heart of worker classification is the common-law concept of control. The question is whether the business has the right to direct and control not only the final result of the work but also the means and methods used to achieve that result. If a business specifies how, when, and where the work is done, it points toward an employer-employee relationship, suggesting the worker is not operating an independent trade or business.

Conversely, a relationship with an independent contractor focuses on the end product. The business contracts for a specific outcome, but the worker retains the autonomy to decide how the work is completed. For instance, a company hiring a painter as an independent contractor would specify which walls to paint and the color, but the painter would use their own tools, set their own hours, and determine their own painting techniques.

This separation between directing the result and directing the method is the central principle guiding the analysis.

The IRS Framework for Classification

To determine a worker’s status, the IRS has grouped the evidence of control into three categories. Businesses must weigh all the facts of a particular case, as no single factor is decisive. The overall picture that emerges from the relationship is what guides the final determination.

Behavioral Control

This category examines whether the business has the right to direct and control how the worker performs the task. Facts that show behavioral control include the level of instruction and training provided. If a business gives detailed instructions on when, where, and how to work, it indicates employee status. This is also true if the company requires the worker to attend training. Control is also evident when a business sets the worker’s hours, requires the work to be performed on the company’s premises, or dictates the sequence in which tasks are performed.

Financial Control

Financial control looks at whether the business has the right to direct the financial and business aspects of the worker’s job. A key indicator is how the worker is paid; payment by the hour, week, or month points toward an employee relationship, while payment by the job is more common for independent contractors. Other considerations include whether the worker has a significant investment in their own equipment and facilities and whether they can realize a profit or suffer a loss. If the business provides the tools and equipment and reimburses business or travel expenses, this suggests an employee relationship.

Relationship of the Parties

This category considers how the worker and business perceive their interaction. Written contracts describing the relationship are a starting point, but not the final word. The permanency of the relationship is also a factor, as a continuous, ongoing relationship suggests employment, while independent contractors are engaged for specific projects with defined end dates.

Other facts that illustrate the nature of the relationship include whether the worker’s services are a part of the regular business operations. If the success of the business depends on these services, an employee relationship is more likely. The ability to work for more than one firm at a time and make services available to the public are indicators of independent contractor status. The right of the business to discharge the worker, and the worker’s right to terminate the relationship at any time without incurring liability, are traditional features of employment.

Tax Implications of Classification

The final classification has direct tax consequences. If a worker is an employee, the employer is responsible for withholding federal income taxes, Social Security, and Medicare taxes from the employee’s wages. The employer must also pay its share of Social Security and Medicare taxes, as well as federal unemployment (FUTA) taxes. At the end of the year, the employer must provide the employee with a Form W-2, which reports the annual wages and taxes withheld.

If the worker is an independent contractor, the tax responsibilities shift to the worker. The worker is responsible for paying their own income tax and self-employment taxes, which cover both the employee and employer portions of Social Security and Medicare. The business must issue a Form 1099-NEC to any independent contractor paid $600 or more during the year.