Walk Like a Contract Project Manager

It’s a happy day for you.  You’re a project manager and you’ve just landed your next job.  Life is good!  Both you and your new client agree that you will be working as an independent contractor and not as an employee.  You’ll pay your own taxes and your client will file form 1099-MISC.  As evidence of this intent, you signed an Independent Contractor Agreement. In your mind, the question of your employment status is settled.

From your client’s perspective, however, there’s far more to consider.  For tax purposes, your client must make a correct determination of your status.  The question your client must consider isn’t whether you both agree that you are an independent contractor.   The question your client must carefully consider is whether the IRS would find that you are an independent contractor.  By misclassifying your status with the IRS, your client could be exposed to substantial liabilities, including penalties and the payment of back taxes that should have been withheld from payment to you.  To your detriment, a later reclassification of your status may also expose you to denial of certain business-related deductions.

For this reason, some organizations are hesitant to hire an independent contractor, even if a contractor is the best fit.  If your livelihood is derived from being a contractor, you should understand how to be classified as one for tax purposes.  Learning to walk the walk might also help you land more opportunities.

Whether the IRS determines that a person is an independent contractor or an employee will depend on the facts in each case.  Because employment situations vary greatly across a range of conditions and industries, there are many factors to consider.   The rules used for making the determinations account for the flexibility needed to fit all of the individual circumstances.  This means that the rules are not drafted to provide “check a box: yes or no” answers.  There are several gray areas and they are often subjective.

By common law, an individual is found to be an employee when the employer has the right to control and direct the individual.  If the employer (payor) can direct the result of the work and the details of how and when it will be accomplished, the individual is an employee.  When the payor can direct the result of the work to be performed, but not the means and details by which the result is to be accomplished, the individual is an independent contractor. See Professional and Executive Leasing v. Commissioner, 89 T.C. 225 (1987).  It doesn’t matter whether the individual has the freedom to determine how services are performed.  What matters is whether the employer has the legal right to control how the services are performed.  As a general rule, in making a determination, the IRS will exam the degree of control your client has and the degree of independence you have.

To help identify whether you are an independent contractor or an employee, the IRS will consider 20 factors that have been codified in Rev. Rul. 87-41, 1987-1 C.B. 296.  Revenue Ruling 87-41 states, “As an aid to determining whether an individual is an employee under the common law rules, 20 factors have been identified as indicating whether sufficient control is present to establish an employer-employee relationship.”

It’s important to know that not all the factors must be present to find an employee/employer relationship.  In addition, there are no set factors that point to a person being an employee or an independent contractor.    Instead, the factors are used as guides in making the determination. Where there is ambiguity, there is a presumption of an employer-employee relationship.  For these reasons, the 20-factor test does not provide an objective, yes or no answer.

If your client were audited, would you be classified as an independent contractor or an employee?  Are there some things you can do to better position yourself as an independent contractor? There’s one way to know for sure. Consult with a tax professional or a licensed attorney.  While you’re waiting for your consultation, examine the 20-factor test below and consider the following as food for thought.

An employee is required to comply with the employers instructions about when, where, and how work is to be performed. Even if you have complete freedom to act, this control factor is present if your client has the RIGHT to require your compliance with instructions.

Walk the Walk

Independent contractors are not usually subject to a detailed level of control.  When constructing your business agreements consider drafting for evidence of your independence and freedom from detailed control.  Consider using language in your documents that call for your use of best practices, industry standards, and your own professional judgment. Decide whether your proposals should specify the detail of the services you will provide and how they will be provided.  Investigate whether you should exclude your client’s right to control the details of where and how your services will be performed.

Training a worker, requiring them to work with a more experienced worker, and requiring them to attend meetings, indicates that the employer wants the services performed in a particular method or manner.  Training points to evidence of an employee-employer relationship.

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Clients typically do not provide training to independent contractors.  Independent contractors provide their own training.  Consider retaining receipts for the classes, instruction and on-going professional education that you have provided for yourself.  If you need training to serve a particular client, take responsibility for securing and paying for that training yourself.  Ask a professional for guidance if you need to structure the cost of that training into the price for your services.

Integration of the worker’s services into the business operations typically show that the worker is subject to direction and control of the business owner. In other words, if the services you provided are a valuable part of your client’s business operations, your client will have a greater interest in controlling the details of how those services are performed.

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Unless you are providing ongoing services for a project management company or are managing the projects of one company only, the temporary nature of project management mean this one shouldn’t be too difficult.  Ask a professional if there is something further you should consider. At any rate, ensure that you control the how and where of the services you provide.

If the services must be rendered by you personally, presumably the payor is interested in the methods used to accomplish the work, as well as the end results. An employee often does not have the ability to assign their work to other employees.

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Most often, an independent contractor has the ability to assign the work to others. If you are hired for a unique skill or experience that only you possess, absent an agreement to the contrary, it’s possible that your ability to assign your work to others may not be appropriate or permitted. Ask a professional.  As you contract for work, construct your agreements so that you have the ability to assign the work to others.

If the payor hires, supervises, and pays assistants, the worker is considered an employee.

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An independent contractor hires, supervises and pays his or her own assistants pursuant to a contract that requires him or her to provide labor and to be responsible for the result. Be the supervisor, not the supervised.<[/cs_text][/cs_column][/cs_row][/cs_section]

A continuing relationship between the worker and the employer indicates that an employer-employee relationship exists. The IRS has found that a continuing relationship may exist where work is performed at frequently recurring intervals, even if the intervals are irregular.

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As a contract project manager, this shouldn’t pose much difficulty either. As a project ends, the relationship ends.  However, if you are providing services for multiple projects to one organization, use care to structure your agreements so that the relationship terminates upon project completions. Investigate whether there are additional factors to consider.

A factor of control is displayed when the payor establishes the hours of work. It points to creating an employee status.

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An independent contractor sets his or her own schedule. Assume responsibility for setting your own hours rather than having them set for you.  If appropriate, draft your agreements to indicate the times in which you will provide services.  If you can not commit to set times, consider placing this information in your agreement to provide services.

An employee is normally required to work full time for an employer. If the worker must devote substantially full time to the business of the payor, that requirement illustrates control over the amount of time the worker spends working.

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An independent contractor is free to work when and for whom he or she chooses. If this isn’t already established in your agreement to provide services, make certain it is. Ensure you do not restrict your ability to handle additional work.

If the work is performed on the premises of the payor, that factor suggests control over the worker, especially if the work could be done elsewhere. Work performed off site indicates some freedom from control.

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An independent contractor may perform services wherever they desire as long as the contract requirements are performed.  Again, construct the contractual agreement so you maintain control of the how and where of the services you provide. The nature of the project may very well require that every bit of the work be performed onsite.  This is different from the situation where the payor requires you to occupy a desk in their facility, for the sake of being there.

A worker who must perform services in the order or sequence established by the payor is generally an employee.  Often, because of the nature of an occupation, the payor does not set the order of the services.  For a display of control, the payor doesn’t have to dictate the order of services.  The payor must merely retain the right to do so.  This is true, regardless of whether they exercise the right.

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An independent contractor performs the work in whatever order or sequence they desire, as long as they meet their contractual obligations. In your contract for services, set forth the order in which you will perform services or state that you will select the order based upon best practices or industry standards for project management.

A requirement that the worker submit regular or written reports to the payor indicates a degree of control and creates the appearances of an employer-employee relationship.

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As a project manager, you will be providing reports concerning the health of the project you are managing.  In your contract to provide services, set your project status reports and all other reports as deliverables that you will provide. Where appropriate, state the intervals that they will be provided.  Ask a professional if there is anything further you should consider.

Payment by the hour, week, or month generally points to an employer-employee relationship.   This method of payment is viewed differently though when it’s merely a convenient way of paying an agreed upon amount.

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Firm fixed price billing indicates that the worker is an independent contractor.  If you are billing by the hour, consult a professional.  As a professional, it’s possible that hourly billing may not create an appearance of an employee-employer relationship.  Ask also whether your invoices should include the services provided and the time spent delivering those services.   At any rate, avoid the situation where you are required to submit a timesheet in exchange for payment.

The business and/or traveling expenses of employees are often paid by their employers.

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Independent contractors pay their own business and travel expenses.  Assume responsibility for paying them and factor those costs in your agreement to provide services.

Employers typically furnish the tools, materials and other equipment that are used by an employee.

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Independent contractors furnish their own computer, phone, space and software.  If an unusual tool or piece of equipment is required for a particular project you are managing, factor the cost of leasing or acquiring it in your agreement with the client.

A lack of investment in facilities indicates dependence on the payor.  This creates the appearances of an employer-employee relationship.  Alternatively, if a worker invests in his or her own facilities, like office space, that factor tends to indicate that the worker is an independent contractor.

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An independent contractor invests in his or her own facilities. Maintain receipts of your office expenses. In the case of leased space, maintain a copy of your lease.  Consult with a professional if you operate from a home office.  Perhaps he or she will suggest you maintain records of your deductions for home office space and keep receipts of expenses you incurred to transition the space to a working environment.

A worker who cannot realize a profit or suffer a loss as a result of the worker’s services is generally an employee. Employees are typically paid for their time and have no liability for business expenses.

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If you are working under a firm fixed agreement, you have the potential to realize a profit or suffer a loss.  When working under a time and materials agreement, the question of your status becomes less clear.  In this case, consult with a professional for the best course of action.  Perhaps it’s possible that, on a time and materials agreement, you may still suffer a loss as a result of the services you provide.  Question whether your liability for your own professional negligence may represent one example.  If so, the declarations page of your professional liability insurance policy may be evidence of your potential to suffer a loss, regardless of contract type.

Typically, an employee works for one employer at a time.  However, a person can work for more than one company and be an employee of each.

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Unlike employees, independent contractors perform services for several unrelated companies at the same time.  If you perform services for one client only, you should certainly ask a professional if there are factors you should consider to avoid looking like an employee. Perhaps it’s enough that you are actively seeking additional work.

Employees don’t make their services available to the general public, once they are employed.

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Independent contracts make their services available to the general public on a regular and consistent basis.  Keep records and receipts of your advertising and marketing endeavors. If you don’t at least have a business card, get one. Engage in other forms of advertising and marketing as well.

Employers have the right to discharge employees.  In many cases, they don’t even need a reason to discharge the employee, as long as the reason is not an illegal one.

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Absent an agreement to the contrary, an independent contractor cannot be fired so long as the independent contractor produces a result that meets the contract obligations.  Your agreement should specify what, if any, are the events that would permit either party to terminate the agreement.  Independent contractors have a right to receive the contractually agreed upon amount in exchange for fulfilling their contractual duties.

Employees can quit work at any time without incurring liability.

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An independent contractor can’t quit any time they’d like.  They are bound by the terms of their contract and have a duty to perform the contractually agreed upon services. As stated above, your agreement should specify what, if any, are the events that would permit you to terminate the agreement.

In addition to the 20-factor test described above, there are many other factors to consider.  For example, the IRS has identified three categories of evidence that may be relevant in determining whether the requisite control exists under the 20-factor test. These factors are grouped under three categories: (1) behavioral control; (2) financial control; and (3) relationship of the parties. There is also an emerging 7-factor test being used by the United States Tax Court.  Safe harbor provisions exist and Form SS-8 can be filed and the IRS will make a determination of the worker’s status.  Because the rules are complex and can be subjective, and because the relevant factors may change over time, it’s in your best interest to consult with an attorney or tax professional before making any changes to the way you currently do business.

Nothing in this blog post should be considered tax or legal advice. The author is neither a tax professional and is certainly not your attorney.

The 20-factor test is discussed above to illustrate that an independent contractor is a self-employed person.  He or she determines the course of their own business and should operate independently from the direction and control of their clients.  If it is your intent to conduct business as an independent contractor, we merely suggest that you do yourself and your client a favor by consulting with a professional to make sure you are walking the walk.