Rev. Rul. 87-41 prefaces the explanation of the 20 factors with a caveat that restricts its value because it limits the ability to generalize: "the degree of importance of each factor varies depending on the occupation and the factual context in which services are performed. The 20 factors are designed only as guides . . .; special scrutiny is required in applying them . . . ."

Research indicates that certain information can be generalized and that all factors are not weighed equally by the courts. Some are more compelling than others, regardless of occupation. Certain factors are cited routinely and even labeled as "important;" others are mentioned rarely. There appears to be a distinct hierarchy of importance of factors which is not being communicated adequately to the public.

IMPORTANCE OF "CONTROL"

The overriding element in assessing employee or independent contractor status is whether the service recipient has the right to control the activities of the service provider. As early as 1947 the Supreme Court in U.S. v. Silk listed "degree of control over the means by which the work is to be accomplished" as the first in a list of six criteria to decide worker status. "The decisive test is whether the employer has the right to control and direct the servant in the performance of his work and in the manner in which the work is to be done. By 1976 the concept of control evolved to whether the service provider "had the right to control and direct the details and means by which operators would accomplish their task, as well as the end results to be accomplished. This factor is important because an employee is subject to the will and control of the employer, not only as to what is done, but how it should be done" (Godwin Stations, Inc.).

Rev. rul. 87-41 specifically picks up case law that evolved by stating "generally the relationship of employer and employee exists when the person or persons for whom the services are performed have the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so."

It's the Details that Make the

Difference

Because the service recipient engages an employee or an independent contractor to perform a task, the right to dictate the "result to be accomplished" cannot determine a worker's status. However, because the service recipient has the right to control the details, manner, and means by which the work is done only in an employer-employee relationship, the distinguishing element is which party has the right to control the details of the work to be performer.

CLASSIFICATION

A distinction exists among the 20 factors as to which ones provide the most compelling evidence of control. The factors can be classified as "primary" or "secondary" factors.

Primary Factors

Eight primary factors provide very persuasive evidence of employee status. Revised to include facts gleaned from court cases and rewritten to indicate an employer-employee relationship, the primary factors are grouped as follows:

1. Right to direct details of work:

* Service recipient has the right to require compliance with significant instructions (IRS factor #1);

* Service recipient has the right to set the hours of work (#7);

* Service recipient has the right to set the order or sequence of services to be performed (#10);

* Service recipient has the right to discharge the service provider (#19); and

* Service recipient has the right to hire, pay, and supervise assistants as the nature of the work requires (#5).

2. Trade or business characteristics:

* Service recipient pays by the hour, week, or month (#12); and

* Service provider has no ability to realize a profit or loss (#16);

* Service provider has no investment in significant tools, materials, and other equipment when such items are necessary to accomplish the task and are customarily provided by the service provider (#14); and

* Service provider has no significant investment in facilities when they are necessary to accomplish the task and they are customarily provided by the service provider (#15).

Secondary Factors

Twelve secondary factors provide less persuasive evidence of employee status. At best they imply that it might exist. Rewritten to indicate the possibility of employee status, the secondary factors are grouped as follows:

1. Training and progress reporting factors:

* Service recipient trains the service provider (#2); and

* Service recipient has the right to require oral or written reports (#11).

2. Compensation factors:

* Service recipient pays by the hour, week, or month (#12); and

* Service recipient pays for business and/or travel expenses (#13).

3. Working relationship factors:

* Service recipient has the right to requite personal services (#4);

* Service provider usually does not work for more than one firm at a time (#17);

* Service provider works on service recipient's premises (#9);

* Service provider maintains a continuing relationship with the service recipient (#6);

* Service provider devotes substantially full time to the service recipient (#8);

* Service provider has the right to terminate relationship at any time without incurring liability (#20); and

* Service provider is integrated into the service recipient's business (#3).

4. Trade or business factors:

* Service provider does not make his or her services available to the public on a regular or consistent basis (#18).

These factors are more subjective and more difficult to assess than the primary factors. Possibly because of their lesser importance, these factors were not always noted in court cases. As detailed later, a few secondary factors contradict themselves. Because no pattern of occurrence exists, individually these factors provide less reliable evidence of a status. However, when detected as a group they are persuasive. Therefore, they are best suited to reinforce the status suggested by the primary factors.

PRIMARY FACTORS

EXPLAINED

Primary factors relate to two issues: 1) the service recipient's right to direct the details, manner and means of the work to be accomplished and 2) the service provider's lack of customary characteristics of engaging in a trade or business.

Right to Direct Details

The first five primary factors are inter-related and are found in many employee cases. The right to require compliance with a service recipient's instructions is the essence of control. Through instructions the service recipient has the right to dictate the details, manner, and means by which the service is provided. By requiring adherence to instructions, the service recipient can set the hours, place, and order of work. Coupled with the right to discharge the service provider for noncompliance with instructions, the presence of all of these factors represents a strong indication of employee status; their absence denotes independent contractor status.

Right to Require Compliance with Significant Instructions. Per Rev. Rul. 87-41 "a worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee." This factor was present in employee cases. In many court cases the service recipient detailed a list of tasks to be performed which suggested control. However, the right to dictate only nominal or insignificant instructions was insufficient to sustain employee status.

Right to Set the Hours of Work. When a service recipient has the right to set a work schedule (e.g., arrival and departure times, coffee breaks, lunch times), a strong element of control exists. In charging their juries, judges stated that a basic test is one of control--whether or not the service recipient had the right at all times to control the actions of these people, their comings and goings and urged them to "consider whether the service recipient had the . . . right to require work at specified times . . . and the number and frequency of breaks ...and ...the working schedule" (King v. U.S.). It appears that the right to set the arrival and departure times is more indicative of control than the right to establish lunch and/or break times which are frequently determined by employees.

Rev. Rul. 87-41 can be misleading. It states "the establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control." The act of establishing work hours is not as significant as the right to set the hours. The important consideration is whether the service recipient had the right to require the service provider to work at specified times, not what hours they actually worked. The right of the service recipient to set the hours of work was stated clearly or implied strongly in all employee cases. An independent contractor relationship was indicated when the service recipient lack this right.

Right to Set the Order of Work to Be Performed. This right is related to the previous factor. While that factor indicates control by providing the right to dictate that a service provider must work, for example, from 9:00 to 5:00, this factor stipulates what must be done from 9:00 to 5:00. It provides the service recipient

FIGURE1

REV.RUL.87-41

THE20FACTORS

1.Instructions

2.Training

3.Integration

4.ServicesRenderedPersonally

5.Hiring,SupervisingandPaying

Assistants

6.ContinuingRelationship

7.SethoursofWork

8.FullTimeRequired

9.DoingWorkonEmployer's

Premises

10.OrderorSequenceSet

11.OralorWrittenReports

12.PaymentbyHour,Week,Month

13.PaymentofBusinessand/or

TravelingExpenses

14.FurnishingofToolsand

Materials

15.SignificantInvestment

16.RealizationofProfitorLoss

17.WorkingforMoreThanOne

FirmataTime

18.MakingServiceAvailableto

GeneralPublic

19.RighttoDischarge

20.RighttoTerminate

with the ability to direct the details of the work. Per Rev. Rul. 87-41 if a worker must perform services in the order or sequence set by those for whom the services are performed, it shows the worker is not free to follow his own pattern of work but must follow the established routines and schedules of those for whom the services are performed. Again the right to set the sequence is distinguishing, not the act of setting it.

Right to Discharge the Service Provider. The right to discharge for failure to comply with instructions or to adhere to set hours or sequence of work is a powerful indicator of control. Rev. Rul. 87-41 provides that "an employer exercises control through the threat of dismissal which causes the worker to obey the employer's instructions." Discharge can be with or without cause. In contrast, an independent contractor cannot be fired so long as the independent contractor produces a result that meets the contractor specifications.

In all employee cases the service recipient's right to discharge was cited or implied. Conversely, in all independent contractor cases there was no mention of the service recipient's right to discharge the service provider.

Right to Hire, Pay and Supervise Assistants as the Nature of the Work Requires. Supervision is a significant factor because it embraces the previous factors. Inherent in supervision is the right to hire and pay workers, establish working hours, set the order of work, demand compliance with instructions, and discharge workers for noncompliance.

Active supervision is often obvious and denotges employee status. Service recipients might oversee service providers by regular monitoring of performance, or via periodic personal visits or telephone calls. The right to reprimand workers for careless performance suggests supervision.

If supervision is less apparent, control can exist if the employer "has a right to exercise such supervision as the nature of the work requires" (Theresa Enterprises, Inc. v. U.S.). If a job does not require substantial skill or employees are well trained, active supervision may be unwarranted so the absence of a need to control should not be confused with the absence of a right to control. The right to control requires only such supervision as the nature of the work requires. In a few cases involving truck unloaders, "the nature of the unloaders' work is such that little supervision is necessary" (McGuire et. al. v. U.S.) and "the unloaders are usually familiar with the standards of the particular warehouse" (Hill Dredging Corporation). For dancers, "if the task of the dancers was so simple that the constant or detailed supervision was not needed, then the lack of actual control over the manner in which the work was performed may be, but no necessarily, of no significance" (Theresa Enterprises, Inc. v. U.S.).

However, the mere existence of some minimal supervision does not necessarily constitute control and denote employee status because "some . . . supervision is inherent in any just undertaking, but that does not make an independent contractor an employee. The test . . . is whether there is any control over the details of the performance of the workers" (Theresa Enterprises, Inc. v. U.S.).

Evaluating the extent of supervision within the entire arrangement is important: ". . . the plaintiff did intervene to some degree; but so does a general building contractor intervene in the work of his subcontractors. He decides how much the different parts of the work must be timed and how they shall be fitted together, if he finds it desirable to cut out this or that from the specifications, he does so. Some supervision is inherent in any joint undertaking and does not make the contributing contractors employees" (Radio City Music Hall Corp. v. U.S.).

In all employee cases the service recipient had the right to hire, pay, and supervise the assistants' work as necessary in the circumstances while in all independent contractor cases the service provider retained these rights.

Trade or Business Factors

The final three primary factors are written to indicate that the service provider is not engaged in a trade or business and employee status exists. However, most of the court cases that discuss these factors are written to justify independent contractor status. Therefore, these three factors are discussed from the perspective that the service provider is engaged in a business activity. When together, they provide compelling evidence that the service provider is engaged in a business, directs the operations, and has the right to control the details of the work, independent contractor status is warranted.

Service Provider Has the Ability to Realize a Profit or Loss. The Supreme Court listed the "opportunities for profit and loss--the risk factor" as an "important" one in determining independent contractor status (Lieb v. U.S.). As noted in Rev. Rul. 87-41, a worker who can realize a profit or suffer a loss as a result of his services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee.

While profits and losses are usually viewed as the difference between revenues and expenses, the risk of "economic loss" is significant. It includes "bona fide liabilities for expenses, such as salary payments to unrelated employees" and "significant investments " (Rev. Rul. 87-41) which subject the owner's capital to loss. The Supreme Court listed "any investment by the person providing the services" as an important factor in denoting independent contractor status.

Service Provider Has an Investment in Significant Tools, Materials, and Other Equipment (#14) and a Significant Investment in Facilities (#15) as Necessary and Customary. A significant investment in equipment and facilities indicates the service providers' assets are at risk.

However, contrary to Rev. Rul. 87-41 the failure of a service provider to provide equipment and facilities is not compelling evidence of employee status. In numerous independent contractor cases the service provider has no investment in facilities. The critical issue appears to be whether there is a need for investment and, if so, which party is usually responsibile for it pursuant to customary trade practices. Independent contractor status was determined when "no investment is required of the service provider" (Bonney Motor Express, Inc. v. U.S.).

"Where equipment is necessary to perform a task, particularly where it is of significant value requiring substantial investment, the person furnishing such equipment in the performance of services may be deemed to be an independent contractor" (McCormick v. U.S.). In many cases independent contractor status was indicated despite a lack of investment in facilities, primarily because it was not customary: e.g., an instructional golf pro did not own the golf course, touring actors did not own the building, part-time barbers did not own the barber shop, and boat captains did not own the boat.

SECONDARY FACTORS

EXPLAINED

Secondary factors include those in which the service recipient has only an implied right to direct the details, manner and menas of the work to be accomplished and provided less convincing evidence of a worker's status.

Training and Progress Reporting

Factors

Service Recipient Trains the Service Provider. Rev. Rul. 87-41 states that "training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner." Although training is often viewed as a broader knowledge-building activity than the daily act of detailing work requirements, its presence is very persuasive evidence of control since through training the service recipient seeks to direct the details of the job.

Lack of training does not necessarily negate employee status. Although in no independent contractor cases was the service provider trained by the service recipient, in at least six employee cases training was never mentioned; in three other cases, no training was provided. The importance of the lack of training seems to hinge on the need to train.

Service Recipient Has the Right to Require Oral or Written Reports. Rev. Rul. 87-41 states that a requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control presumably because the service recipient can review the reports and redirect the details of work, if desired. The inability of the service recipient to mandate such reporting suggests a lack of cotrol. Nonetheless, this factor is unreliable because its significance largely depends upon the nature of the job and the necessity of reporting.

Compensation Factors

Service Recipient Pays by the Hour, Week or Month. Rev. Rul. 87-41 states that payment by the hour, week, or month generally points to an employer-employee relationship unless this method of payment is just a convenient way of paying a lump sum agreed upon as the cost of a job, whereas payment by the job or on a straight commission generally indicates that the worker is an independent contractor.

This factor is inconclusive. Employee status may not be indicated even though the service provider is payd by the hour or week. Actors were paid a weekly rate but were judged to be independent contractors. Similarly, independent contractor status may be unwarranted when payment is made by the job or commission.

Service Recipient Pays for Business and/or Travel Expenses. Per Rev. Rul. 87-41 if those for whom the services are performed ordinarily pay the worker's business and/or traveling expenses, the worker is ordinarily an employee. This factor, too, is inconclusive since many independent contractor billing arrangements require the service recipient to pay out-of-pocket expenses.

Working Relationship Factors

As a group, working relationship factors imply an ongoing relationship between parties. Although their combined presence provides persuasive evidence of employee status, individually they are inconclusive. Not one of them can be construed to provide the right to direct details of the result to be accomplished. Often they are absent from cases or nebulous because of their nature.

Service Recipient Has the Right to Require Personal Services. Per Rev. Rul. 87-41 if the service must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results. This rationale is presumptuous at best because the service recipient could have demanded a particular individual's services because the individual was well trained, experienced and knowledgeable about the service recipient's industry and business, was able to work well with their staff, and had provided excellent previous service at a reasonable fee. Rarely does case law refer to this issue.

Service Provider Usually Does Not Work for More Than One Firm at a Time. Rev. Rul. 87-41 offers contradictory advice: "if a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factors generally indicates that the worker is an independent contractor," but then states: "a worker who performs services for more than one person may be an employee of each person ..., which is typical when an individual works several part-time jobs. Cases rarely refer to this issue.

Service Provider Works on Service Recipient's Premises. Rev. Rul. 87- 41 provides inconclusive, although less contradictory, advice on this factor. It states that if the work is performed on the premises of the service recipient, the recipient has control over the worker, especially if the work could be done elsewhere. However, it also offers that "work done off the premises of the person or persons receiving the services ... by itself does not mean that the worker is not an employee." Adding to the vagueness is the fact that work is often done on the service recipient's premises, usually due to the nature of the services (e.g., dancing, acting, etc.), in many independent contractor cases.

Service Provider Maintains a Continuing Relationship with the Service Recipient (#6) and Service Provider Devotes Substantially Full-Time to the Service Recipient (#8). Both of these factors suggest that the service recipient's right to control is due to a continuing and/or full- time relationship. Rev. Rul. 87-41 states (re: factor #6) that "a continuing relationship between the worker and the person or persons for whom the services are provided indicates that an employer-employee relationship exists" and (re: #8) "if the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work." While these premises appear reasonable, especially over a long period of time, and are generally supported by court decisions, e.g., the relationship of employment generally contemplates a continuous or indefinite rendering of services, they ignore the central issue of controlling the details of the work. Often public accounting firms provide ongoing audit, tax, and management advisory services and have year-round staff on a client's premises, yet they are not employees. Furthermore, the absence of a continuing or full-time relationship does not suggest independent contractor status, nor does the Rev. Rul 97-41 proposition that "an independent contractor ... is free to work when and for whom he chooses" since by the very nature of their jobs, many part-time, seasonal, or transient workers lack a continuing or full-time relationship and move from job to job, but they are correctly designated as employees.

Service Provider Has the Right to Terminate Relationship at Any Time Without Incurring Liability. According to Rev. Rul. 87-41 "if the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship." This factor is mentioned rarely in case law and, thus, appears to be inconclusive.

Service Provider is Integrated into the Service Recipient's Business. According to Rev. Rul. 87-41 "integration of the worker's services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree-upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business." Theoretically, integration of services represents a compelling argument for employee status, yet practically how does one assess it? Arguably, only presence of a preponderance of the above factors suggests integration. Because of its difficulty to measure, integration cannot be a highly reliable factor.

Trade or Business Factor

Service Provider Does Not Make His or Her Services Available to the Public on a Regular or Consistent Basis. Rev. Rul. 87-41 states that "the fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship," since such an activity typifies a business activity in which the service provider directs the details of the work. Courts typically evaluate this factor by ascertaining whether the service provider used a business name, procured necessary licenses, advertised or generally offered their services to the public, listed themselves in the phone directory, or maintained an office. Although these items suggest independent contractor status, this factor was cited only infrequently in cases. Thus, it is best relegated to reinforce the three primary trade or business factors.

EVALUATING THE FACTORS

To ascertain a worker's status, one should evaluate all the facts. Not one of the 20 factors is singularly determinative of a particular status. Case law often includes a judge's charge to the jury to decide the case where a "preponderance of evidence" existed for one status.

Attempting to determine a worker's status by applying the tests in Rev. Rul. 87-41 can be misleading and confusing. Some factors suggest employee status, others denote independent contractor status, and in some instances the absence of certain factors may or may not imply a status. Therefore, it is suggested that a worker's status be determined strictly according to whether one party, e.g., the service recipient, has the right to control the details of the work to be accomplished, which is the distinguishing element of a status. If the service recipient retains the right, employee status is warranted. If the service recipient does not have the right, independent contractor status is indicated.

The Factor Evaluation Questionnaire (Figure 2) is designed to facilitate this determination. It is constructed so that the presence of a factor which suggests service recipient control (i.e., employee status for the service provider) elicits a "yes" response. The absence of a factor, which suggests that control rests with the service provider (i.e., independent contractor status for the service provider), elicits a "no" answer. It is unlikely that all of the questions will be answered "yes" or all will be answered "no". One should not merely determine which status has more than 10 factors and conclude accordingly. Such a strategy ignores that the factors are not weighted equally. In evaluating where the "preponderance of evidence" rests, more weight should be given to the first eight primary factors than to the last 12 secondary factors.

THIRSTING FOR USEFUL

INFORMATION

Conclusive authoritative advice on the determination of worker status is needed. Worker status evaluation is complicated by the subjective guidance provided by Rev. Rul. 87-41. Courts regularly accord greater weight to a few factors and ignore many of the less persuasive secondary factors. This appears to give courts the ability to minimize subjectivity and uncertainty and to insure a degree of consistency in their decisions. A new revenue ruling that does not recognize the eminence of certain factors and eliminate the misleading or contradictory statements contained in Rev. Rul. 87-41 will be of little assistance. Until authoritative advice mirrors the holding of the courts, uncertainty will abound and practitioners will thirst for useful information.

Alan R. Sumutka, MBA, CPA, is an Associate Professor of Accounting at Rider College in Lawrenceville, NJ. He is a member of the AICPAA, AAA, NSPA, and the New Jersey Society of CPAs. Mr. Sumutka's articles have been published in journals including The CPA, Journal, The Tax Advisor, Journal of Accountancy and Taxation for Accountants.