Contractors vs. Employee – What is the Correct Classification?

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Contractors vs. Employee – What is the Correct Classification?

Engineer contractor shaking hands at break down house construction site working architecture planning in sunny weather day.

The construction industry utilizes contractors at a high rate when compared to other industries. It’s not surprising then that employers in this industry are often selected for audits or investigations regarding employment liability.

The Internal Revenue Service (IRS) has grouped the common law factors into three major categories when determining an employer-employee relationship. They are behavioral controls, financial controls, and the overall relationship between both parties. Under these categories, there are factors a federal representative will inquire about to assist in determining worker classification.  The following are the significant factors that are considered:

Behavioral Controls

  • How is the job acquired?
    1. In construction, contractors often obtain the job through a bid or estimate.  Thus, the contractor determines the cost to complete the job and potential revenue.
    2. An employee, however, obtains the job through a job advertisement or job posting.  An employee submits a resume, is interviewed by the employing unit, and the employing unit determines the rate of pay even if the amount of pay is negotiated.
  • Who determines how the service(s) are performed?
    1. A contractor is told the end results of the job and may be given a deadline to complete the job but is otherwise free to follow his own pattern of work.  In addition, personal performance is not required because a contractor has the authority to hire, train, and supervise his own assistants without prior consent from the employing unit.
    2. An employee generally receives training from the employing unit, receives specific instructions on how to perform the job, and is subject to supervision. In other terms, the employing unit is expecting the employee to follow its procedures in order to accomplish the results in a particular manner.

Also, an employee may need prior approval from the employing unit to provide similar services to other entities.

  • Who determines when the services are rendered?
    1. A contractor generally negotiates a schedule and deadline with its clients.
    1. An employee, however, generally performs the service during the employer’s business hours or must follow a schedule established by the employer.

Financial Controls

  • Significant investment in assets and operating expenses. 
  1. A contractor generally provides all of the tools, equipment, and personnel needed to complete the job.  However, the tools and equipment must be of significant dollar amount and for business use only. There isn’t a cost consensus to help determine if an asset is a significant investment.  However, items like hammers, hand-saws, and cordless drills would be considered common tools of the trade and not significant. 

A contractor also has recurring business expenses, such as rent expense, overhead, and payroll expense which puts them in a position to realize a profit or loss.

  1. When the individual is an employee, the employer provides all of the tools, supplies, and equipment and the employer is also responsible for all operating expenses. This puts the employee in a position to realize income only for services rendered and is monetarily dependent on the employer.
  • Reimbursed expenses

A Contractor is responsible for all incurred expenses when performing the service(s). Whereas an employee is generally reimbursed for out-of-pocket expenses with proper receipt or is issued a company credit card but still provides copies of receipts to the employer.

  • Does the Contractor make his services available to the general public?

By advertising his/her services, either through business cards, flyers, company website, newspaper ads, etc., the contractor is being active in soliciting additional work for their entity which is an indicator of being independent. 

Overall Relationship

Other factors to consider in addition to the significant factors noted above are the following:

  • Benefits offered/received from the employing unit?

An individual who receives paid time-off, who is covered under the employing unit’s liability insurance, receives periodic pay raises or bonuses, and other similar benefits will generally be classified as an employee.  A contractor is not given the opportunity to participate in or offered such benefits because, once again, they are responsible for all operating costs.

  • The extent to which the service(s) is an important part or process of the employing unit’s regular business activity.

Example 1:  An individual who personally performs contractor services as a Dental Assistant at a dentist office, uses company equipment to perform the service, has no control over the rate of pay, and has no discretion over what work to accept or deny, would be determined to be an employee.


Example 2: A Plumber fixing an overflowing toilet at a dentist office and who uses his own tools, controls the time when the repair will happen, sets his own rates, and decides the best way to fix the problem, would be properly classified a contractor. 

Moreover, Dentistry and Plumbing are two distinct industries.

  • The permanency of the relationship. Is it an ongoing relationship?  Is there intent to continue a working relationship?

An employee does not have to perform services on a full-time or part-time basis.  An employee can perform services on a temporary, seasonal, or even on an as needed basis; depending on the employing unit’s industry and operations.

Stating to an individual that he or she will receive Form 1099 for services rendered is generally not sufficient for independent contractor classification. Thus, the three categories mentioned above should be noted by business owners and human resources personnel when searching for contractors and/or employees.

With regard to Arizona Employment Security Law, the employer-employee relationship is codified under Arizona Revised Statutes (A.R.S.) § 23-613.01 and the Arizona Administrative Code (A.A.C.) R6-3-1723.  The factors listed under the code are grouped into two categories: control, under (D) (2) (a) through (l); and independence, under (E) (1) through (6).  In addition, other factors not listed under (D) or (E) may also be considered under Subsection (F) in determining whether the employer exercised sufficient control over the worker’s services to constitute employment.

It should be noted that the factors largely mirror the IRS common law factors and, therefore, the analysis of whether a worker is an independent contractor or employee is similar.

Fredy Hernandez is an experienced field auditor formerly with the State of Arizona – DES Unemployment Insurance Tax and now works as a financial and tax accountant at Morrison, Clark & Company CPAs, Chandler, Arizona.  For more information, call (480) 424-7855 or visit

This work is also published as Hernandez, F., Employee vs. Contractor: What is the correct worker classification? Construction Accounting and Taxation 28, no. 5 (2018).