EMPLOYEE OR INDEPENDENT CONTRACTOR:
AN EXAMINATION OF THE RELEVANT VARIABLES EMPLOYED
BY THE FEDERAL COURTS IN DECIDING THE QUESTION
DAVE NELSON STEWART
A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL
OF THE UNIVERSITY OF FLORIDA IN
PARTIAL FULFILLMENT OF THE REQUIREMENTS
FOR THE DEGREE OF DOCTOR OF PHILOSOPHY
UNIVERSITY OF FLORIDA
Dave Nelson Stewart
I wish to thank John L. Kramer, the chairman of this dissertation
committee, for his guidance and support throughout the course of
this study. Professor Kramer has given unselfishly of his time,
especially in the reading and commenting on different drafts of
My entire dissertation committee has contributed greatly to
this project. Professor William A. Collins, Dennis A. Calfee, and
John C. Henretta have each shared freely of their knowledge and
expertise. They have never been too busy to sit down and discuss
the progress of this study. Valuable criticisms and suggestions
were also received from the Ph.D. students and faculty at the
University of Florida Accounting Workshop.
Finally, I would like to thank my dear wife, Jane. She not
only provided constant encouragement and support, but her typing and
editing skills were invaluable to the production of the finished paper.
TABLE OF CONTENTS
ACKNOWLEDGEMENTS . . . . . . . . ... . . .iii
LIST OF TABLES . . . . . . . ... ...... vi
ABSTRACT . . . . . . . ... . . . . . .vii
I. INTRODUCTION . . . . . . .. .. ... . 1
Significance of the Problem . . . . . . . 2
Research Methodology . . . . . . . . . 7
Research Questions . . . . . . . . 7
Data Collection . . . . . . . . . 8
Research Question 1 . . . . . . . . 9
Research Question 2 . . . . . . . .. 10
Research Question 3 . . . . . . . . 11
Research Question 4 . . . . . . ... 12
Limitations . . . . . . . . ... . . 13
Summary of Chapter Contents . . . . . ... .14
Notes . . . . . . . . . . ... 15
II. HISTORICAL BACKGROUND . . . . . . . ... 19
Development of Legislative History . . . . .. 19
Social Security Act of 1935 . . . . ... 19
Common Law Definition of Master-
Servant Relationship ............. 21
Social Security Amendments of 1939 . . ... .24
Income Tax Withholding Provisions . . . ... 26
Judicial Interpretation . . . . . .. 27
Social Security Amendments of 1950 . . ... .34
Current Legislative Status . . . . . . ... 38
Revenue Act of 1978 . . . . . . ... 43
Current Proposed Solutions . . . . . . ... 44
General Accounting Office . . . . . . 44
H.R. 3245; Safe Harbor Remedy . . . . ... 46
Department of the Treasury . . . . ... .49
Notes . . . . . . . . . . . ... 50
III. RESEARCH METHODOLOGY . . . . . . . .
Research Question 1 . . .
Operational Definitions of
Coding of the Variables
Research Question 2 . . .
Mathematical Techniques in
Discriminant Analysis .
Logit Analysis . . .
Research Question 3 . . .
Research Question 4 . . .
Notes . . . . . . .
IV. EMPIRICAL RESULTS . . . .
. . .
Research Question 2 . . . . . .
Discriminant Analysis Results .
OLS Regression Results .. . ...
Logit Analysis Results . . . .
Comparisons of Discriminant, OLS
Regression, and Logit Analyses .
Research Question 3 . . . . . .
Research Question 4 . . . . . .
Notes . . . . . . . . .
V. SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS .
Summary and Conclusions . . . . .
Historical Background of Common Law
Variable Identification . . .
Empirical Results . . . . .
Temporal Stability of the Model .
Current Legislative Proposals .
Choice of Legal Forum . . . .
Recommendations . . . . . . .
Suggestions for Future Research . . .
Notes . . . . . . . . .
. . . 121
. . . 121
. . . 121
. . . 136
. . .. 142
. . .
A. LIST OF DISTRICT COURT CASES INVOLVING THE EMPLOYEE
VERSUS INDEPENDENT CONTRACTOR QUESTION . . .
B. LIST OF COURT OF CLAIMS CASES INVOLVING THE EMPLOYEE
VERSUS INDEPENDENT CONTRACTOR QUESTION . . ... 176
BIBLIOGRAPHY . . . . . . . . ... ... . 177
BIOGRAPHICAL SKETCH . . . . . . . . ... . . 187
LIST OF TABLES
1.1 A COMPARISON OF THE FICA AND SECA TAXES
FOR 1978 THRU 1987 . . . . .
4.1 BMDP 6-VARIABLE MODEL . . . . .
4.2 SPSS 9-VARIABLE MODEL . . . . .
4.3 COMPARISON OF CLASSIFICATION ACCURACY .
4.4 DISCRIMINANT & CLASSIFICATION COEFFICIENTS
FOR THE 6-VARIABLE MODEL . . . .
4.5 CLASSIFICATION ACCURACY MATRICES . .
4.6 MODEL BASED ON 22 DUMMY VARIABLES . .
4.7 CLASSIFICATION ACCURACY MATRIX ..
4.8 TEMPORAL STABILITY TEST OF
CLASSIFICATION ACCURACY . . . . .
4.9 OLS REGRESSION RESULTS . . . . .
4.10 OLS STEPWISE REGRESSION RESULTS . . .
4.11 COEFFICIENTS AND CLASSIFICATION
MATRIX FOR FULL 11-VARIABLE MODEL . .
4.12 COEFFICIENTS AND CLASSIFICATION MATRIX
FOR THE BMDP 5-VARIABLE MODEL . . .
4.13 COMPARISON OF STEPWISE RESULTS . . .
4.14 CLASSIFICATION ACCURACY FOR
CHOICE OF FORUM TEST . . . . .
4.15 FACTORS CONTAINED IN ALL THREE PROPOSALS
4.16 CLASSIFICATION ACCURACY MATRICES
FOR THE 3-VARIABLE MODELS . . . . .
. . . 122
. . . 124
. . . 126
. . . 127
. . . 129
. . . 131
. . . 132
. . . 135
. . . 137
. . . 139
. . . 143
. . . 145
. . . 147
. . . 152
. . . 155
. . . 157
Abstract of Dissertation Presented to the Graduate Council
of the University of Florida in Partial Fulfillment of the
Requirements for the Degree of Doctor of Philosophy
EMPLOYEE OR INDEPENDENT CONTRACTOR:
AN EXAMINATION OF THE RELEVANT VARIABLES EMPLOYED
BY THE FEDERAL COURTS IN DECIDING THE QUESTION
Dave Nelson Stewart
Chairman: John L. Kramer
Major Department: Accounting
The distinction between an employee and an independent contractor
is crucial in the application of the federal employment tax laws. If
a worker is classified as an employee, the employer must (1) withhold
income taxes, (2) withhold social security taxes, (3) match the social
security taxes paid by the employee, and (4) pay unemployment taxes.
If the worker is classified as an independent contractor, the employer
need not pay or withhold any of the above mentioned taxes. Instead,
the independent contractor is responsible for paying his own income
and self-employment taxes.
The Internal Revenue Code statutorily defines several occupational
categories that are treated as employees for employment tax purposes.
The most prominent of these categories is that of a "common law"
employee. However, the scope of the Code and Regulations is sufficiently
limited to leave the common law employee definition shrouded in uncer-
tainty. It is this ambiguity, coupled with the IRS's increased
enforcement of employment taxes, that has resulted in pressure on
Congress to enact legislation that will add a degree of certainty
to the definition of a common law employee. The legislation being
considered by Congress would result in several "safe harbor" criteria
that if satisfied would automatically indicate employee status.
The purpose of this study is to develop a mathematical model
that will empirically identify those variables used by the federal
courts in employee versus independent contractor cases in hopes
that these variables may provide direction to tax policymakers.
A sample of 148 District Court and Court of Claims cases was iden-
tified and used as the data with which the mathematical models were
estimated. Discriminant analysis, OLS regression analysis, and a
non-linear logit analysis were all used to identify those variables
deemed most important by federal judges.
A forward stepwise discriminant procedure resulted in a 6-variable
model that was able to correctly classify 96.6 percent of the cases.
A forward stepwise OLS regression procedure resulted in a 7-variable
model that correctly classified 95.3 percent of the cases and explained
80 percent of the variance of the model. The non-linear stepwise
logit procedure resulted in a 5-variable model that was able to correctly
classify 97.3 percent of the cases. Both the linear and non-linear
techniques produced substantially identical results.
When compared with the proposals presently being considered by
Congress, three of the variables recommended by the Congressional
subcommittee are also included in this study. Using these three vari-
ables as the model, approximately 90 percent of the cases were correctly
A secondary question addressed in this study is whether the choice
of legal forum is important in an employment status tax case. Through
a comparison of the discriminant classification accuracy rates and the
Chow test applied to the OLS results, it was concluded that for employ-
ment tax cases the two Federal Courts use very similar decision-making
The findings of this study suggest several conclusions. First,
the use of the non-linear analysis did not produce substantially
different results than did the linear regression or discriminant
analysis procedures. Second, there are factors that have been used
successfully by federal judges in employment tax cases that could
provide direction to tax policymakers attempting to statutorily define
a common law employee. Third, the decision-making models employed by
the District Courts and the Court of Claims are not significantly
different for federal employment tax cases.
Until the 1960's, the collection of federal employment taxes--
withholding, social security, and unemployment--followed a relatively
smooth course for employers and other taxpayers. However, since the
late 1960's, the Internal Revenue Service (IRS) has increased its en-
forcement of the employment tax laws. The question of employment
status generally centers around the classification of whether a worker is
an independent contractor or an employee. Because so few categories
of employees are statutorily defined, the question of whether a worker
is an independent contractor or an employee generally centers around the
issue of what constitutes a "common law" employee. The common law
definition of employee has evolved from a substantial body of case law.3
Congress initially felt that all uncertainty in the classification of an
individual as an employee or an independent contractor would "vanish if
only common law principles distilled from many decisions by many courts
were applied to factual situations as they arose." The assumption that
. there is some simple, uniform and easily applicable
test which the courts have used . unfortunately . .
is not true. Few problems in the law have greater variety
of application and conflict in results than the cases arising
in the borderland between what is clearly an employer-employee
relationship and5what is clearly one of independent-entrepre-
The substantial amount of litigation in the federal employment tax
area is evidence that the common law definition of an employee is easier
stated than applied. The determination of employment status is an
issue on which both the taxpayer and the government desire some degree
of closure. The taxpayers complain that the retroactive reclassification
of workers as employees and the resulting taxes, interest, and penalties
are causing interruption of business activities and financial hardship
through severe cash flow demands.7 The IRS is claiming that with the
uncertainty surrounding the common law rules that taxpayers are able to
easily avoid employee status. Since this results in no withholding of
taxes by the employer, independent contractors are easier able to
escape detection should they fail to file their tax returns.
Consequently, proposals have been forthcoming from a Congressional
9 10 II
subcommittee, the General Accounting Office, and the IRS that
recommend the solidification of the many factors that determine a common
law employee into a smaller number of factors that provide a more clear-
cut test. However, these factors lack theoretical support and in some
cases even lack the desirable tax characteristics of simplicity and
certainty. The purpose of this study is to determine those factors that
the courts have found significant in defining employment status with
the hope that these variables may prove helpful to tax administrators
as they search for an appropriate definition of the employee-employer
relationship. Such a study could provide valuable insight into what
factors can be consistently applied when individuals are faced with the
task of determining if a worker is an employee or independent contractor.
Significance of the Problem
Once the court determination is made that a certain individual is
an "employee," the employer may have the following responsibilities:
(1) withhold social security taxes under the Federal Income Contributions
Act (FICA),12 (2) withhold federal income taxes, 13 (3) match the FICA
taxes paid by the employee, and (4) pay unemployment taxes under the
Federal Unemployment Tax Act (FUTA).15 When an individual is clas-
sified as an independent contractor the purchaser of his services
need not pay or withhold any of the above mentioned taxes. The pur-
chaser of the services may only need file an information return (Form
1099).16 It is then the responsibility of the independent contractor
to pay self-employment taxes under the Self-Employment Contributions
Act (SECA)17 and pay his own income taxes through the use of the
estimated tax procedures.8 With inflation pushing wages into higher
tax brackets and prospective increases in both the FICA and SECA wage
bases and rates,9 the amount of employment taxes can vary substantially
according to one's employment status.
Table 1.1 represents the present and proposed FICA and SECA tax
rates and wage bases from 1978 to 1987. Columns (5) and (6) illustrate
that the social security taxes are substantial and will drastically
increase in the next ten years. Column (7) shows the differences in the
actual tax that goes into the Social Security Fund depending on the
employment status. The difference in what an employer must pay is even
more pronounced when one includes the FUTA taxes (3.4% of the first
$6,000 of wages per employee). For example, using the maximum wages
applicable to employment taxes for 1980, Column (7) shows that an ad-
ditional $1,077.44 of taxes are paid into the federal treasuries if a
worker is an employee versus an independent contractor. This difference
of $1,077.44 should be increased by the FUTA taxes of $204 (3.4% x
6,000) that are also imposed thereby resulting in a total difference
of $1,281.44. Consequently, Column (7) probably represents for most
A COMPARISON OF THE FICA AND SECA TAXES
FOR 1978 THRU 1987
(1) (2) (3) (4) (5) (6) (7)
Max. Max. Excess FICA
FICA SECA Wage FICA SECA Maximum over
Year Ratea Rate Basec Tax Tax Maximumd
7 % $ $ $ $
1978 12.10 8.10 17,700 2,141.70 1,433.70 708.00
1979 12.26 8.10 22,900 2,807.54 1,854.90 952.10
1980 12.26 8.10 25,900 3,175.34 2,097.90 1,077.44
1981 13.30 9.30 29,700 3,950.10 2,762.10 1,188.00
1982 13.40 9.35 31,800 4,261.20 2,973.30 1,287.90
1983 13.40 9.35 33,900 4,542.60 3,169.65 1,372.95
1984 13.40 9.35 36,000 4,824.00 3,366.00 1,458.00
1985 14.10 9.90 38,100 5,372.10 3,771.90 1,600.20
1986 14.30 10.00 40,200 5,748.60 4,020.00 1,728.60
1987 14.30 10.00 42,600 6,091.80 4,260.00 1,831.80
aThis percentage includes both the employer's and the employee's
portion of the FICA tax. This percentage includes the social security
rate and hospital insurance rates as contained in Section 3101.
This percentage includes the self-employment rate and the hospital
insurance rate as contained in Section 1401.
CAny wages above these specified amounts are not subject to FICA
or SECA tax.
This amount is obtained by subtracting column (6) from column
taxpayers a conservative estimate of the total additional taxes paid
when a worker is deemed to be an employee.
The preceding illustration is based simply on the differences in
employment taxes between an independent contractor (self-employed) and
an employee. The determination of employment status can be much more
critical if the IRS should choose to reclassify an independent contrac-
tor as an employee. The employer would then be assessed for the income
taxes he failed to withhold, both the employer and employee FICA
taxes that should have been paid by the employer, and the FUTA taxes
that should have been paid,22 plus the appropriate interest and penal-
ties. Such assessment can be made retroactively for all tax years
that remain open under the statute of limitations (generally three
years under Section 6501). Only if the employer can furnish certifi-
cates signed by his employees stating that they have paid the proper
amount of income tax, can the employer possibly have the assessment
reduced.24 The employer can have the employee's share of the FICA tax
abated by the SECA tax already paid only if the employee is prevented
by law from filing for a refund of the SECA tax that he paid in error.2
This situation obviously results in a double payment of the employee's
share of the FICA tax.
A reclassification by the IRS causes even more problems for
employers because of the Tax Court's lack of jurisdiction over employ-
ment taxes. Therefore, a suit cannot be instigated by a taxpayer
without payment of the assessed tax because the District Courts and
Court of Claims require the payment of the assessment prior to their
judicial review. To require a business to pay three years worth of
income, FICA, and FUTA taxes while instituting a legal action against
the government could impose severe hardship and cost upon a firm.
However, since employment taxes are generally paid on a quarterly basis,
the taxpayerordinarily files a return covering one quarter's employment
taxes and then sues for a refund of that amount and abatement of the
yet unpaid amount.27 This partial payment procedure can still involve
a considerable amount of funds when dealing with industries that have
a large number of workers that would be affected by such a determination.
Jerome Kurtz, Commissioner of the Internal Revenue Service, in a speech
before the American Bar Association pointed out:
The employee independent contractor issue has generated a
staggering problem for employers assessed with huge liabili-
ties for past noncompliance. At present, in two districts
of one region alone there are three potential assessments
against taxpayers ranging from $6 million to $60 million . .
and reclassification of independent contractors as employees
result in deficiency assessments estimated at $107,000,000
Even if the taxpayer only has to pay one quarter's worth of employment
taxes to initiate a suit for refund and abatement of the IRS assessment,
the IRS is not precluded from seizing a taxpayer's property in this
type of partial payment litigation.29 This action is not taken in most
situations unless the IRS feels there are circumstances which might
jeopardize the availability of the taxpayer's funds subsequent to the
litigation.30 This threat exists in employment tax cases as evidenced
by American Consulting Corporation v. U.S.31 where the IRS seized a bank
account owned by the plaintiff whose employment status was being ques-
The determination whether a worker is an employee or an independent
contractor is far more reaching than simply the employment taxes in-
volved. The reclassification of an independent contractor can have
adverse effects on a firm if it has a qualified pension, profit-sharing,
or stock bonus plan. Such a reclassification may cause the plan to
violate the minimum participation requirements. This could cause the
disallowance of deductions taken for contributions to the plan and
possibly even taxation of the trust's income.32 This would most
likely result in termination of the plan by the employer because of the
increased expense or at best the effect would be to reduce the benefits
available to the employees. Workers who consider themselves self-
employed and establish Keogh plans for their own retirement may find
that prior contributions are disallowed or the plan frozen with
respect to any future tax exempt contributions.
Reclassification of workers as employees instead of independent
contractors affects various other fringe benefits. Employees exclude
from income any contribution paid by their employer for accident and
health plans,33 employee education assistance plans,34 certain employer-
provided life insurance and death benefit programs, and the value of
any meals or lodging furnished for the convenience of the employer.36
Independent contractors are not afforded these privileges. In addition,
other sections of the Code that apply specifically to employees would
be affected by any reclassifications by the IRS. For example, the
WIN tax credit for wages paid to certain employees hired under the
Federal Work Incentive program37 and the targeted jobs credit for wages
paid to certain new employees are all examples of areas of the tax
law affected by reclassifying independent contractors as employees.
The four major research questions that are studied in this
Research Question 1.
Research Question 2.
Research Question 3.
Research Question 4.
What factors or variables have been used in
determining employment status?
In constructing a mathematical model of the
courts' decision-making behavior, which of the
variables espoused in Research Question
I prove to be significant?
In determining the employment status of the
cases examined, do the different courts of
original jurisdiction (District Courts versus
Court of Claims) use similar factors in the
rendering of decisions?
a) Do the variables determined in Research
Question 2 have any similarity with the
criteria in the current proposals before
b) What possible recommendations might these
The Regulations specifically state that a common law employee is to
be determined according to the facts of each case. The facts of a
case are determined in the original court of jurisdiction. In this type
of study, the assumption must be made that because of the possibility
of appeal to a higher court, judges attempt to include in their opinions
a discussion of the relevant facts in their decision-making process.
With this assumption, the Lexis computer data bank was used to search
for all employee versus independent contractor cases.0 From Lexis and
other manual research methods a total of 179 cases were identified for
the 1940 through 1979 period. The year 1940 represents the first year
in which a significant number of cases were tried that dealt with the
employment status question in connection with federal employment taxes.
The study also includes all the cases that could be found through
the end of the 1979 calender year.
Of the 179 cases, 24 were tried with a jury. In this situa-
tion, the written opinions contain only the instructions to the jury
and the actual verdict. Therefore, these 24 cases were eliminated
from the study. Sixteen cases also were eliminated because there was
not sufficient information in the opinion to determine what factors
the judge considered in his decision. This leaves a total of 139
cases of which 119 were tried in the District Courts and 20 were tried
in the Court of Claims (for a list of cases see Appendices A and B).
A small number of cases were discovered at the appellate level that
had not been reported at the District Court or Court of Claims level.
These cases were also excluded because the facts of a case are determined
in the court of original jurisdiction.
Research Question 1
The sources examined to determine the relevant factors in deciding
employment tax cases for federal tax purposes include the following:
(1) the Internal Revenue Code, (2) the corresponding Treasury Regula-
tions, (3) certain landmark judicial decisions,1 and (4) a BNA Tax
Management portfolio entitled Employee Defined.42 Another source that
proved helpful was the Employment Tax Procedure audit guidelines
published by the IRS for their agents.43 The list of factors that was
compiled was reduced as the court cases were read and it became evident
that certain factors seldom were discussed in the court opinions or
that two variables were so highly correlated that they were combined
and represented as only one variable. A list of the complete set of
variables used in this study is contained in Chapter III with additional
explanation of the selection process, operational definitions of the
respective variables, and how they were measured for this study.
Research Question 2
In constructing a mathematical model of a court's decision-making
behavior, three different approaches were taken. First, a discrimi-
nant analysis model was built using the variables espoused in the
results of Research Question I and the model was used to classify the
court cases as either an employee or an independent contractor outcome.
The P7M program of the Biomedical Computer Programs P-Series (BMDP)44
computer software package was used to derive the discriminant function.
From this discriminant function, classification functions for each of
the two groups were derived. Each case was then assigned to the group
in which the highest probability of membership existed.
A frequently recommended technique to test the accuracy of the
classification function is that of using a holdout sample. However,
with the limited number of cases available in this study, an alternate
test was applied.45 This technique calculated n-1 discriminant func-
tions where n is equal to the number of cases in the sample. The
procedure involved calculating a discriminant function with all but
one case, and then that function was used to classify the left out
case. The procedure was repeated n-1 times, and the number of incor-
rectly classified cases was used as an estimate of the probability of
misclassifying an employee versus independent contractor case.
Second, an ordinary least squares (OLS) regression model was built
using the variables espoused in the results of Research Question 1.
The OLS model was used to generate a probability of an employee
finding versus an independent contractor finding for each case.
These probabilities were used to classify each case. These classi-
fications were compared with those obtained from the discriminant
model to determine if these two linear statistical techniques gener-
ate different results.
Certain statistical assumptions are violated by using either of
the preceding linear modeling techniques. Therefore, the third
approach taken was to use logit analysis which is a non-linear es-
timation technique. Logit analysis assumes that the underlying func-
tional form of the relationship being studied is curvilinear and
estimation of the model allows for interaction of the independent
variables. The logit model involves a transformation of the depen-
dent variable from a binary to a continuous random variable. The
logit model was estimated using the Nerlove and Press and the
BMDP stepwise logistic regression programs which generate maximum
likelihood (ML) estimates. The ML estimates were used to generate
probabilities for each case by which they could then be assigned
to either the employee or independent contractor groups. These
results were compared with the discriminant analysis and OLS re-
gression results to determine if linear and non-linear estimation
techniques produced different results.
Research Question 3
To determine if the District Courts and Court of Claims apply
different factors in deciding an employee versus independent contrac-
tor case, the first approach used in this study was to build a
discriminant function using only the District Court cases. The
resulting classification functions were used to classify both the
District Court and Court of Claims cases. If the misclassification
rates are significantly higher for the Court of Claims cases, this
will be taken as evidence that the two courts use different decision-
The second approach used to determine if the District Courts
and Court of Claims use different decision-making models was to
build two additional OLS regression models. The first model was
based exclusively on the District Court cases and the second model
was based exclusively on the Court of Claims cases. The Chow test4
was used to determine if the two regressions came from the same
population. The results of this test along with the results of the
discriminant analysis test were used to draw conclusions pertaining
to the similarity of the two courts with respect to deciding common
law employee versus independent contractor cases.
Research Question 4
The preceding research questions were designed to discover which
variables are significant to the courts in deciding the employee
versus independent contractor question. The results are based on
the facts of the cases as discussed by the respective judges. The
logical extension of this research is to determine if the variables
found to be significant in Research Question 2 are related to the
criteria contained in the proposals before Congress. If the criteria
are quite different from those determined in this study, tax policy
makers may want to reconsider those variables that have been suggested
in order to provide a more certain definition of an independent con-
tractor. If the results of this study produce variables that have
been consistently used by judges in rendering decisions in employ-
ment status cases, it would seem that these variables would be a
good starting point for legislation. Therefore, the factors ob-
tained from Research Question 2 were compared with the current
proposals before Congress. Similarities were noted and recommen-
dations made of additional factors that Congress may want to con-
sider in the actual drafting of legislation in the employment tax
This study attempts to identify those factors that a diverse
set of judges have consistently used in deciding the employee versus
independent contractor question. To do so, a research methodology
was used that provides for a more systematic approach than the
legal analysis that is generally used to study problems of this
type. While the advantage may be that the approach is more objec-
tive than legal analysis which depends on the researcher's own
heuristics, it also suffers from certain limitations. The greatest
limitation of this type of study is the reliance on the fact that
the judge has actually included in his written opinion all of the
significant variables he used in his decision process. If a sig-
nificant variable is not included in the written opinion, it can
not be measured and considered in this type of study. This problem
is somewhat mitigated by the fact that the judge knows his opinion is
subject to reversal for failure to consider all relevant facts.
The ability to reduce the data in the written opinions into a
numerical form also presents some problems. In an attempt to re-
duce the subjectivity involved in actually obtaining the data, a
variable generally was not assumed present unless it was explicitly
noted in the text of the case. Each case was read several times
by the author in an attempt to be consistent in the actual coding
of the variables.
It should also be noted that because of the dynamic structure
of the tax law and the legal process, that the results of this study
are not predictive in a future sense unless one assumes stability
for all the factors affecting the employee versus independent con-
tractor question. The fact that the data are based only on cases
that were actually litigated also produces a potential sample bias.
The majority of cases that are actually litigated are cases in which
both parties feel they have a reasonable chance of winning. It
is not clear if this bias is very crucial because it is those very
situations where the decision is in doubt that this study is in-
terested in investigating.
Summary of Chapter Contents
This study is divided into five chapters. Chapter I is the
introduction to the study which includes a brief discussion of the
nature and scope of the problem, the research questions to be
addressed, the basic research methodology to be used, and possible
limitations of the study.
Chapter II provides a historical perspective of the common
law definition of employee by tracing its use through the Code and
corresponding regulations. This historical background is supple-
mented by a discussion of the current legislative status of common
law employees and also proposed legislation that is currently being
considered by Congress.
Chapter III presents a more detailed outline of the research
methodology that was used. Chapter III also examines Research
Question I which outlines the selection of the variables used in
the study along with their operational definitions.
Chapter IV describes the discriminant, OLS regression, and
logit analyses that were used to model the courts' decision-making
behavior. The empirical results of each of the three techniques
are analyzed. The differences and similarities of the three
techniques are then evaluated.
Chapter V summarizes the preceding chapters. In addition,
implications of this study are discussed and recommendations for
future research are made.
ISmith, Independent Contractor or Employee?--That is the
Question, 33 N.Y.U. INSTITUTE ON FEDERAL TAXATION 578 (1975).
JOINT COMMITTEE ON TAXATION, ISSUES IN THE CLASSIFICATION
OF INDIVIDUALS AS EMPLOYEES OR INDEPENDENT CONTRACTORS 7 (1979).
GENERAL ACCOUNTING OFFICE, TAX TREATMENT OF EMPLOYEES
AND SELF-EMPLOYED PERSONS BY THE INTERNAL REVENUE SERVICE: PROBLEMS
AND SOLUTIONS 5 (1977).
S. REP. No. 1255, 80th Cong., 2d Sess., p. 7 as cited
in M.F.A. Mutual Insurance Co. v. U.S., 314 F. Supp. 595 (W.D. Mo.
5National Labor Relations Board v. Hearst Publications,
322 U.S. 120,121 (1944).
See the list of cases in Marmoll, 391 TAX MNGM'T (BNA),
'EMPLOYEE' DEFINED, pp. c-6 thru c-10 (1979).
GENERAL ACCOUNTING OFFICE, supra note 3, at 13.
Id. at 23.
H.R. 3245, 96th Cong., 1st Sess., 125 CONG. REC. E 1342
(daily ed. March 27, 1979) (remarks of Rep. Gephardt).
GENERAL ACCOUNTING OFFICE, supra note 3.
1 Hearings on H.R. 3245 Before the Subcommittee on Select
Revenue Measures, 96th Cong., Ist Sess. 5 (1979) (statement of
Donald C. Lubick).
12 Section 3102(a).
13I.R.C. Section 3102(a).
14I.R.C. Section 3402(a).
15I.R.C. Section 3301.
16I.R.C. Section 6041(a).
I7.R.C. Section 1401.
18I.R.C. Section 6015.
I91.R.C. Sections 1401, 3101, and 3111.
I.R.C. Section 6205(a)(I) and Treas. Reg. Section 31.620
I.R.C. Section 6205(a)(1) and Treas. Reg. Section 31.620
22I.R.C. Section 6157(a).
2.R.C. Sections 6601,6651, and 6653.
2I.R.C. Section 3402(d).
I.R.C. Section 6521(a).
I.R.C. Section 7442 and Shaw v. U.S., 331 F. 2d. 493
(CA 9th 1964).
2See Marvel v. U.S., 548 F. 2d. 295 (10th Cir. 1977) as
cited in JOINT COMMITTEE ON TAXATION, supra note 2, at 8.
2North, The Employment Tax Morass, 11 CREIGHTON LAW REVIEW
29I.R.C. Sections 6321, 6331, and 6862.
30JOINT COMMITTEE ON TAXATION, supra note 2, at 9.
311 F. Supp. 715 (W.D. Pa. 1970).
I3.R.C. Section 404(a)(5).
I.R.C. Section 106.
34I.R.C. Section 127.
35.R.C. Section 79.
I.R.C. Section 119.
37I.R.C. Sections 40, 50A and 50B.
38I.R.C. Section 51.
39Treas. Reg. Section 31.3121(d)-l(c)(3).
40Lexis computer data bank is simply a huge data base con-
sisting of several libraries, one of which is the Tax Library. In
this library, among other things, all reported cases since 1960
for the District Courts and all cases since 1942 for the Court of
Claims are stored in its memory. Through a determination of words
and phrases common to a selected subject, the researcher can obtain
a listing of all cases relevant to that issue. For the years not
contained in the Lexis system a manual search was performed to
identify the relevant cases.
4U.S. v. Silk, 331 U.S. 704 (1947) and Bartels v. Birm-
ingham, 332 U.S. 126 (1947).
4Marmoll, supra note 6.
INTERNAL REVENUE SERVICE, INTERNAL REVENUE MANUAL CCH,
ch. 4600, pp. 8463-1 thru 8463-5.
44BMDP BIOMEDICAL COMPUTER PROGRAMS P-SERIES 711 (W. Dixon
& M. Brown ed. 1979).
4Lachenbruch, On Expected Probabilities of Misclassifi-
cation in Discriminant Analysis, Necessary Sample Size and a Relation
with the Multiple Correlation Coefficients, 24 BIOMETRICS 823-834
M. Nerlove & M. Press, Univariate and Multivariate Log-linear
and Logistic Models, RAND CORPORATION TECHNICAL REPORT R-1306-EDA/NIH
4BMDP, supra note 44, at 517.
4Chow, Tests of Equality between Sets of Coefficients
in Two Linear Regressions, 28 ECONOMETRICA 591 (1960).
Development of Legislative History
Social Security Act of 1935
With the devastating effects of the great depression on
unemployment, attention was keenly focused on establishing the
means by which such a calamity might be avoided in the future.1
On January 28, 1934, an Executive Order of the President of the
United States created the Committee on Economic Security.2 On
January 15, 1935, the Committee submitted its report which Congress
promptly used as the substance for the drafting of legislation.
The Social Security Act of 19354 came after long deliberation by
both the President and the Congress on "the evil of the burdens
that rest upon large numbers of our people because of the insecur-
ities of modern life, particularly old age and unemployment."5
The original Social Security Act included eleven "Titles." Of
principal concern for this study is Title VIII which created provi-
sions dealing with old age benefits, Title IX which created provi-
sions dealing with unemployment compensation, and Title XI which
provided the definitions to be used in the other ten Titles. The
principal solution adopted by Titles VIII and IX was to provide for
periodic payments similar to annuities to the elderly and to provide
for compensation to workers during sustained periods of unemployment.
The enactment of employment taxes was the method adopted by Congress
to fund payments to the elderly and the unemployed.
The primary purpose of this study is to determine the parties
to whom the employment taxes apply. Title VIII of the original
Social Security Act, provided for a tax on both the employee and
employer of percent of the employee's "wages." Wages were defined
in Section 811 of the Social Security Act as
. all remuneration for employment, including the cash
value of all remuneration paid in any medium other than
cash; except that such term shall not include that part of
the remuneration which, after remuneration equal to $3,000
has been paid to an individual by an employer with respect
to employment during any calendar year, is paid to such
individual by such employer with respect to employment
during such calendar year. (Emphasis added)
One of the key terms used in this definition of wages was "employ-
ment" and Section 811 defined employment as "any service, of what-
ever nature, performed within the United States by an employee or
The unemployment provisions of Title IX basically provided for
an excise tax to be levied on employees of 1 percent of the employees'
wages if the employer had eight or more employees. The determination
of whether an individual qualifies as an employee is critical in the
application of the Title IX provisions. Title XI simply defines an
employee as "an officer of a corporation." The absence of an elab-
orate definition of employee in either title seems to imply a "will-
ingness of Congress to allow the courts to determine to whom the
statute should apply."6
Regulations were issued in 1936 by the Treasury that expanded
the employee definition for both the old-age and the unemployment
tax provisions. The Regulations provide in part that
. within the meaning of the Act, any person is an
employee if he is in the service of one or more employers
. for compensation. An individual is in the service
of an employer if he is subject to the continuing authority
of the employer to supervise and direct the manner in
which he renders services for compensation. 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.
The right of an employer to discharge an individual is
also an important factor indicating that the individual
is an employee. Other factors indicating that an indivi-
dual is an employee are the furnishing of tools and the
furnishing of a place to work by the employer to the
individual who performs the services. In general, if an
individual is subject to the control or direction of an
employer merely as to the result to be accomplished by
the work and not as to the means and methods for accom-
plishing the result, he is an independent contractor.
An individual performing services as an independent
contractor is not, as to such services, an employee
within the meaning of the Act.
A comparison of this Regulation to the "definition" found in leading
cases and legal authorities will disclose that the Regulation is
substantially a brief statement of the common law definition of
the master and servant relationship.
Common Law Definition of Master-Servant Relationship
Maitland provides the following as a reasonable definition of
the common law:
The Common Law (called also the unwritten law, or from
its mode of development, the customary law) embraces
those rules of civil conduct which originated in the
common wisdom and experience of society, became in time
established customs, and finally received judicial
sanction and affirmance in the decisions of the courts
of last resort.0
This system of common law was originally established through the
decisions reached by the English common law courts of Exchequer,
Common Pleas, and the King's Bench as early as the year 1300.11
What helped promote the advancement of the common law was the
increase in the recording of court decisions and the resulting
increased availability of admissible legal precedent.12 At first,
court proceedings were circulated primarily only to judges and
select lawyers.3 But as the availability of court decisions
became more widespread, citation of precedent also became more
prevalent by lawyers and more accepted by the courts. From
this beginning, "the common law system was refined, worker over,
modified, improved, and increased as the centuries passed until
there developed an entire body of law."15
Even though the acceptance of the English system of law by
the early American colonists was not immediate, the English system
eventually did triumph as the principal source of American law.1
With England's control over the original colonies, legal matters
generally dealt with England and the English system. This also
resulted in the training received by the early American lawyers to
be heavily concentrated in English law. In addition to England's
influence on the colonies, another significant reason for the accep-
tance of the English system was the fact that English was the primary
language of Americans and the majority of early legal writing was
done in English.9 For whatever reasons, the English system of law
(including its common law) was the basis of the early American system
The common law is a "comprehensive body of law" providing a
"comprehensive system of remedies."20 Contained within this broad
system of law is a body of case law and legal thought dealing with
the master and servant relationship. The determination of whether
or not a master-servant relationship existed was of primary impor-
tance under English common law in assessing the "liability of a
master for a tort committed by a servant who was acting within the
scope of his employment.21 The question of a master-servant rela-
tionship also has become important in cases involving workmen's
compensation, contracts, and of primary importance to this study,
the area of employment taxes.
The 1936 Treasury Regulations dealing with employment taxes
were promulgated pursuant to the common law definition of the
master-servant relationship as defined by the American judicial
system. An early example of the application of the common law
definition of the master-servant relationship was in an 1889
Supreme Court case dealing with whether a corporation which had
hired a commission salesman was liable for a negligent act of that
same salesman.22 The salesman was furnished with a wagon which
was to be used exclusively in canvassing for sales.23 The salesman
was convicted of driving the corporation's horse and wagon care-
lessly which resulted in personal injury to Katie Rohn as she
crossed a local street. The Supreme Court held that the salesman
was a servant of the corporation and that such corporation was
responsible for Katie Rohn's injuries.25 In arriving at this
decision, the Supreme Court cited Railroad Co. v. Hanning as
authority for the definition of a master-servant relationship
S. the relation of master and servant exists when-
ever the employer retains the right to direct the manner
in which the business shall be done, as well as the
result to be accomplished, or, in other words, "not
only what shall be done, but how it shall be done."26
In a later case, the Supreme Court used this same definition
in a situation dealing specifically with employees and independent
contractors.27 In concluding that the workers involved in this
case were independent contractors, the Supreme Court held that the
parties had the "liberty of action which excludes the idea of that
control or right to control by the employer which characterizes
the relation of employer and employee and differentiates the
employee or servant from the independent contractor."28
From this evolution of the common law comes the concept of
the master-servant relationship that is contained in the two
Supreme Court decisions discussed previously. Even though the
term common law employee is not specifically mentioned in the
1936 employment tax Treasury Regulations, the definition attri-
buted to an employee by the Treasury Department is similar to that
espoused by the two decisions discussed above. These two decisions
are merely representative of many early decisions that use this
same common law definition.29 Consequently, at the very incep-
tion of the social security provisions, the notion of a common law
employee assumed a position of importance as far as determining
to whom the provisions applied.
Social Security Amendments of 1939
The social security provisions were re-examined four years
after the enactment of the original Social Security Act and prior
to the codification of the existing tax law into the 1939 Code.
The Social Security Board recommended that the coverage of the
social security provisions be expanded.30 Arthur J. Altmeyer.
Chairman of the Social Security Board, in hearings before the House
Ways and Means Committee recommended that the social security pro-
S. be expanded to the extent feasible to cover more
of the persons who furnish primarily personal service.
The intention of such an amendment would be to cover
persons who are for all practical purposes employees,
but whose legal status may not be that of an employee.
Using essentially the same language, the House adopted the
Board's recommendation for the old-age insurance portion of the
social security provisions.32 However, for some unexplained reason
the House failed to include this expanded definition for the unem-
ployment tax provisions.33 When the House proposal went to the
Senate Finance Committee, the expanded definition of employee was
deleted from the bill because it was "believed inexpedient to
change the existing law which limits coverage to employees."
Therefore, the employee definition that was codified in the 1939
Code was substantially unchanged from the original Social Security
Act of 1935. Title VIII was codified into the 1939 Code as Sec-
tions 1400 through 1432, referred to as the Federal Income Con-
tributions Act (FICA). The unemployment tax provisions were codi-
fied into the 1939 Code as Sections 1600 through 1611, referred
to as the Federal Unemployment Tax Act (FUTA). The 1939 FICA
Treasury Regulations were also substantially unchanged from the
language contained in the original 1936 employment tax Treasury
Income Tax Withholding Provisions
In 1942, in an attempt to raise additional funds to support the
war effort, Congress enacted what was known as the Victory Tax.38
This tax was a temporary income tax that was levied in addition to
the normal tax and surtax. The Victory tax amounted to 5 percent
of "Victory Tax net income," but was limited in as much as it could
not result in a total tax greater than "90 percent of the indivi-
dual net income."39
Because of the substantial tax rates that existed during World
War II, the Treasury suggested for the first time that income taxes
be withheld at the source.40 The Treasury recommended this pro-
cedure as a method of aiding taxpayers in meeting their tax payments
with a minimum strain.
Greater equity and fairness is gained for the great body
of income-tax payers by more uniform application of the
law, and the administrative problem of collection, espe-
cially in the case of taxpayers who move from one locality
to another, will be made easier.4
The House adopted the recommendation of the Treasury and intro-
duced legislation that would require withholding of income taxes at
the source on dividends, bond interest, and wages. As with the
FICA and FUTA provisions, the question of whether the withholding
requirements applied to a given individual had to be answered. The
House expressed the view that the common law rules which developed
largely in the field of tort law would be "unnecessarily restric-
tive if they stood alone as the tests for withholding tax purposes.
The definition of employee is accordingly drawn to cover
all common law servants, and in addition such other indi-
viduals performing services as are not in reality inde-
pendent businessmen or independent practitioners of a
profession, whether or not they are "independent contrac-
tors" at common law. Thus under this definition an indi-
vidual may be an employee even though he is not subject
The Senate for reasons of "simplicity" and "ease of administra-
tion" required that collection at the source of payment be limited
to salaries, wages and other forms of compensation for personal
services."45 The more surprising result, and of greater impor-
tance to the tracing of the common law definition of an employee,
was the fact that in the Conference Committee the scope of the
withholding provisions was limited to those individuals coming
under the common law definition of an employee.46
A year later, the definition of employee that became incor-
porated in the Victory Tax provisions was extended to the regular
income tax area by the Current Tax Payment Act of 1943.47 By so
doing, Congress expanded the application of the common law employee
definition from the social security tax area to the income tax
area while at the same time resisting pressure to expand the def-
inition of employee beyond that encompassed by the common law rules.
Therefore, it was not until 1947 and the introduction of the eco-
nomic reality test that the common law definition of employee was
Economic Reality Test. In 1947, the Supreme Court considered
three federal employment tax cases which gave rise to what has been
termed the "economic reality test.48 Of these three cases, the
Supreme Court decided both the Silk and Greyvan Lines cases together
on June 16, 1947.
The Albert Silk Coal Company was in the business of selling
coal at retail in the city of Topeka, Kansas. The question being
considered by the Supreme Court in this case was whether workmen
engaged in unloading railroad cars and truck drivers who made
retail deliveries of the coal were employees for purposes of the
employment tax provisions. The unloaders were paid an agreed
price per ton to unload coal from the railroad cars. The men
provided their own tools, worked when they desired, and were free
to work for other employers.49 When an unloader came to the yard
he was assigned a car to unload and told where it was to be unloaded.
Some of the unloaders were quite regular workers while others were
"floaters"and came to the yards only intermittently.50
Since Silk owned no trucks of his own, he contracted with
individuals who owned their own trucks to deliver the coal at an
agreed upon price per ton. The truckers were able to come and go
as they pleased, were able to haul for others if they desired,
paid all their own operating expenses, furnished their own helpers
when needed in delivering the coal, and were able to refuse to make
certain deliveries without suffering any penalties. The truckers
were not instructed in how to perform their services, but simply
were given a delivery ticket and told whether the purchase was cash
or charge.52 No record was kept of the truckdrivers' time and they
settled up with Silk Coal Company by the trip, by the day, or by
the week according to the truckdriver's wishes.
Greyvan Lines, Inc.,was a household-furniture trucker operating
in thirty-eight states and part of Canada.54 Similar to Silk, the
question that was decided by the Supreme Court was whether the
truckmen who hauled the household furniture were employees under
the employment tax provisions. These truckers were required to
furnish their own trucks, haul exclusively for Greyvan Lines, pro-
vide any assistants needed to deliver the furniture, pay all oper-
ating expenses, carry the specified insurance coverage, drive their
own trucks, and follow any regulations and instructions issued by
Greyvan Lines.55 These instructions covered directions as to where
and when to load and deliver the furniture. Compensation was deter-
mined on a commission basis with a bonus for successful completion
of a job.
The Supreme Court held that the unloaders in the Silk case
were employees.56 The Court explained its decision as follows:
(1) the tools the unloaders provided were only picks and shovels,
(2) they had no opportunity for gain or loss except through their
own manual labor, (3) the fact that many did not work regularly
was insignificant, and (4) since the unloaders did work in the
course of the employer's regular trade or business, they should
come under the employment tax provisions.5
On the other hand, the Supreme Court held that the truckers
in both cases were independent contractors. Even though on the
surface, the description of the relationship of the truckers to
their respective employers seemed quite different, the Supreme
Court's opinion did not distinguish between the two cases with
respect to the trucker's verdict. The Court indicated that even
though the Greyvan Line truckers hauled just for one firm. this
distinction was not controlling in the rendering of its decision.59
The Court held that the truckers were small businessmen who owned
their own trucks and that "it is the total situation, including
the risk undertaken, the control exercised, the opportunity for
profit, from sound management, that marks these driver-owners as
The Silk and Greyvan decisions themselves are not the most
significant factors of these two cases. Despite the Congressional
mandate that the common law rules were to determine if the employ-
ment relationship existed in other than the statutorily defined
cases,61 the Supreme Court in Silk opted for an expanded defini-
tion of employee.
As the federal social security legislation is an attack
on recognized evils in our national economy, a con-
stricted interpretation of the phrasing by the courts
would not comport with its purpose. . Here the
District Courts and the Circuit Courts of Appeals deter-
mined the cages largely if not indeed exclusively by
applying the so-called "common law control" test as
the criterion. This was clearly wrong in view of the
Court's present ruling.62 (Emphasis added)
The Supreme Court in Silk also listed the following factors as
important in determining whether employment status actually is
present: (1) degree of control, (2) opportunities for profit or
loss, (3) investment in facilities, (4) permanency of relation,
and (5) skill required.63 With respect to these factors, the
Court states that "no one factoriess controlling nor is the list
complete."64 The Supreme Court's opinion definitely speaks of
the degree of control as simply one of several factors to be
applied and not as the overall test.
The Supreme Court upheld both the Silk and Greyvan Lines
opinions a week later in another employment status case, Bartels
v. Birmingham.65 This case deals with orchestras hired to play
for limited engagements; usually one-night stands. The question
being decided by the Supreme Court in this case is whether the
band leaders and other members of the band were the employees of
the dance establishments.
These bands are "built around a leader whose name, and
distinctive style in the presentation and rendition of dance
music, is intended to give each band a marked individuality."66
The leader hires and fires the musicians, fixes their salaries,
tells them what and how to play, and pays all of their transpor-
station and operating expenses. It is also the band leader who
contracts with the dance establishments to play at a specified
The Supreme Court held that the band leaders were the employers
of the individual musicians and in turn the band leaders were
independent contractors with respect to the dance establishments.69
In explaining its opinion, the Supreme Court stated that a band
leader organizes and trains the band, selects the members, and
bears the risk of losses that might occur.70 The relationship
between the band leader and his orchestra is relatively permanent,
while the relationship between the band and the dance establish-
ments is only temporary.7
In issuing the Bartels opinion, the Supreme Court cited the
Silks case and restated the notion that the common law employee
definition for employment tax purposes was "not to be determined
solely by the idea of control which an alleged employer may or
could exercise over the details of the service rendered to his
business by the worker or workers.72 The Court goes on to suggest
that determination of an employer-employee relationship is a matter
of "economic reality."73 Again, the Supreme Court was emphasizing
that it is the total situation that controls, not simply the
the common law control test.
These three 1947 cases were not the first instancesin which
the economic reality test was espoused by the Supreme Court.
Before the test was introduced into the employment tax area, the
Supreme Court had already applied the economic reality doctrine
in National Labor Relations Board v. Hearst Publications. In
Hearst Publications, the Supreme Court held that newsboys were
employees under the National Labor Relations Act.7 In interpreting
the Act, the court stated that "Congress had in mind a wider field
than the narrow technical legal relation of master and servant"
and because of the broad language in the Act's definitions, there
is "no doubt that its applicability is to be determined broadly,
in doubtful situations, by underlying economic facts rather than
technically and exclusively by previously established legal classi-
fications."76 After the economic reality test was introduced in
the labor relations area, the Supreme Court held in the Silk case
that "application of the social security legislation should follow
the same rules that we applied to the National Labor Relations
Act in the Hearst case. This then completes a brief history
of the advent of the economic reality test and its integration
into the federal employment tax area.
Status Quo Amendment. With the success of the Supreme Court
in altering the common law employee definition first in the labor
relations area and then in the federal employment tax area, the
Treasury Department quickly attempted to alter its employee defi-
nition by issuing Proposed Regulations in 1947.78 These Regula-
tions attempted to substitute the economic reality test for the
common law control test in determining employment status for FICA
and FUTA purposes.79 These Regulations would have reduced the
"right to control the performance of services by an individual"
to simply one of several factors that should be examined in deter-
mining employment status instead of the overall test as envisioned
by Congress in the original enactment of the social security pro-
Congress viewed the Proposed Regulations as an attempt by the
Treasury Department to usurp the authority of Congress in making
The issue involved in the proposed regulations is whether
the scope of social-security coverage should be deter-
mined by Congress or by other branches of the Government
. accordingly, under the proposed regulations, the
question of coverage will be determined, not by Congress,
but by the Social Security Agency, the Treasury, and the
By joint resolution, Congress responded to the Proposed Regulations
by passing legislation that would maintain the "status quo" of the
current statutes and regulations and reaffirm the legislative intent
of the original Social Security Act of 1935. The intent was that
the usual common law rules, realistically applied, would continue
to be used to determine employment status for social security pur-
poses.83 The accompanying Senate Report stated emphatically that
the "end point determination" is whether there is an absence or
existence of control and that whatever factors are pertinent to
this determination should be used.84 But the final determination
is whether or not control actually exists.
To further emphasize their desire to have the common law
control test be the primary test of employment status, Congress
added the following language to the FICA and FUTA provisions:
. such term does not include (1) any individual who,
under the usual common law rules applicable in determining
the employer-employee relationship, has the status of an
independent contractor or (2) any individual (except an
officer of a corporation) who is not an employee under
such common law rules.
This is the first time that the common law definition of employee
was officially included in the statute. Previously, support for
its application had been obtained either from legislative history
of the social security provisions or the employment tax Treasury
Social Security Amendments of 1950
Congressional support for the Status Quo Amendment was strong
enough that it was passed over the veto of President Truman.86
Representative Gearhart explained the actions of Congress as
If this Congress had not interfered, tens of thousands
of people in America who never dreamed they were employed
by anybody and never for one moment thought they were
covered by social security or subject to payroll taxes
would have found that they had been swept into the social
security system by bureaucratic ukase. In other words,
they would suddenly have found that they had more employers
than a dog has fleas. So, to end this confusion, Congress
acted promptly and, after thorough-going debate, by a
vote of nearly 7 to 1, proceeded by legislation to put
the matter in order once again by restoring the ancient
doctrine of the common law defining the relation of
master and servant, employer and employee.87
Despite this strong Congressional reaction to the Treasury's
Proposed Regulations, in the very next Congressional session the
Social Security Administration recommended the repeal of the Status
Quo Amendment and enactment of the economic reality test.8 The
House adopted the proposal and passed H.R. 6000 which would have
incorporated the economic reality test as a general definition of
an employee for social security purposes.8 Also the bill stat-
utorily determined that the following seven occupational groups
would be classified as employees for the withholding and payment
of social security taxes: (1) an outside salesman in the manufac-
turing or wholesale trade, (2) a full-time life insurance salesman,
(3) a driver-lessee or a taxicab, (4) a home worker, (5) a contract
logger, (6) a mining lessee or licensee, and (7) a house-to-house
The Senate did not accept H.R. 6000 as it was passed by the
House. Instead, the Senate deleted the economic reality test,
reaffirmed the common law definition of employee, and reduced the
number of occupational categories to certain agent or commission
drivers and full-time insurance salesmen.9 Therefore, the economic
reality test was again specifically rejected by Congress for use in
resolving the employment status question. For FICA purposes, the
same definition of employee that was enacted in 19502 has not
been substantially changed to date. In the next section of this
chapter, this definition is reproduced in its full text as Section
3121(d) of the Internal Revenue Code of 1954.
Before analyzing the current legislative status of the common
law definition of employee, it is appropriate to consider another
relevant piece of legislation that was introduced by the Social
Security Amendments of 1950. To this point, this entire histor-
ical background discussion has been concerned with the FICA and
FUTA provisions as they relate to the overall social security package
adopted by Congress. No mention has been made of the status of
the self-employed worker who did not come under the social security
provisions discussed thus far. Another significant aspect of the
1950 amendments was the extension of the social security provisions
to self-employed individuals.93
The self-employment tax provisions were codified in the 1939
Code as Sections 480-482. Section 482(b) states that subchapter
E (which contains Section 480-482)may be cited as the Self Employ-
ment Contributions Act (SECA). The original SECA provisions pro-
vided for a tax on "self-employment income."95 Self-employment
income was defined as "net earnings from self-employment derived
by an individual" except (1) those net earnings from self-employment
that are less than $400 and (2) those net earnings from self-
employment in excess of $3,600 (which first had to be reduced by
any wages received that had been subjected to the FICA taxes under
Section 1426(b) of the 1939 Code).96
The term "nct earnings from self-employment" were defined as
the "gross income derived by an individual from any trade or busi-
ness carried on by such individual," less certain deductions.97
The term trade or business was defined to have the same meaning
as it did in Section 23 of the 1939 Code which dealt with the
ordinary and necessary expenses incurred in connection with a trade
or business that could be deducted in arriving at net income.98
Section 481(c) contained an except clause that applied to the
Section 23 definition of a trade or business which resulted in
the exempting of certain activities from the self-employment tax.
The most important 481(c) exception for this study was the "per-
formance of services by an individual as an employee.99 Section
481(d) referred to the FICA provisions to define the term employee.
The FICA definition of employee, as has been discussed in considerable
detail, means a common law employee. With this link to the FICA
provisions, Congress had effectively extended the coverage of the
social security provisions beyond merely employees and provided the
means by which self-employed persons would now be subject to employ-
Sections 1401-1403 are the 1954 Code counterparts of Sections
481-483 of the 1939 Code. In substance, the self-employment tax
provisions have been altered slightly in the past 30 years, but
essentially their import is the same.00 The most salient aspect
of the SECA provisions for this study is that because of their
construction, they provide a clear distinction between how an
employee and and independent contractor will be treated for employ-
ment tax purposes. It is this distinction that has contributed
to the increased importance of being able to determine when a
common law employer-employee relationship actually exists.
Current Legislative Status
For FICA purposes, the Internal Revenue Code of 1954 defines
an employee substantially as it was defined after the 1950 amend-
ments. Section 3121(d) defines an employee for FICA purposes as:
(1) any officer of a corporation; or
(2) any individual who, under the usual common law
rules applicable in determining the employer-employee rela-
tionship, has the status of an employee; or
(3) any individual (other than an individual who is an
employee under paragraph (I) or (2)) who performs services for
renumeration for any person--
(A) as an agent-driver or commission-driver engaged
in distributing meat products, vegetable products, bakery
products, beverages (other than milk), or laundry or dry-
cleaning services, for his principal;
(B) as a full-time life insurance salesman;
(C) as a home worker performing work, according to
specifications furnished by the person for whom the services
are performed, on materials or goods furnished by such a person
which are required to be returned to such person or a person
designated by him; or
(D) as a traveling or city salesman, other than as
an agent-driver, engaged upon a full-time basis in the
solcitation on behalf of, and the transmission to, his
principal (except for side-line sales activities on
behalf of some other person) of orders from wholesalers,
retailers, contractors, or operators of hotels, restaurants,
or other similar establishments for merchandise for
resale or supplies for use in their business operations;
if the contract of service contemplated that substantially all
of such services are to be performed personally by such in-
dividual; except that an individual shall.not be included in
the term "employee" under the provisions of this paragraph if
such individual has a substantial investment in facilities
used in connection with the performance of such services
(other than in facilities for transportation), or if the
services are in the nature of a single transaction not part of
a continuing relationship with the person for whom the services
are performed. (Emphasis added)
It is Section 3121(d)(2) dealing with common law employees
that is of principal interest in this study. A common law employee
is one of the classes of employees that is subject to the FICA
withholding and payment requirements. However, all six categories
of employees defined in paragraph (d) are subject to the if clause
that follows the Section 3121(d)(3)(D) definition of a traveling or
city salesman. Ignoring the language not pertinent to this study,
paragraph (d) could be paraphrased as follows: an individual is
treated as an employee- for the FICA provisions if he is considered
an employee under the usual common law rules applicable in determining
the employer-employee relationship if the contract of service
contemplates that all the services would be performed personally
by the common law employee in question; except if such common law
employee has a substantial investment in facilities used in con-
nection with the performance of such services or if the services
are in the nature of a single transaction and not part of a con-
tinuing relationship with the person for whom the services are
This interpretation of the statute would mean that a common
law employee is subject to the FICA withholding and payment re-
quirements only if he satisfies the "if clause" discussed above and
also does not come within either of the situations described in the
"except clause." Even though personal performance of the services,
substantial investment, and a continuing relationship are all
factors that are considered in applying the usual common law
definition of employee, this statutory construction places these
three factors as additional requirements that must be satisfied
before an adjudged common law employee can be subjected to the FICA
In the 139 cases included in this study, the argument never
was presented to the courts that a common law employee should be
excepted from the FICA withholding and payment requirements due to
the statutory exceptions contained in paragraph (d) of Section
3121. Marmoll concludes that "there has been a tendency in the
authorities to de-emphasize--primarily through silence--the statu-
tory exceptions set forth in Section 3121(d)."I02 Additional dis-
cussion is devoted to these statutory exceptions in Chapter III
when the factors are defined that are used in building the mathe-
matical models developed in this study. The additional discussion
in Chapter III is included in the definitions of factor 3 (right
to delegate) and factor 4 (continuing relationship).
Treasury Regulation Section 31.3121(d)-l(c) further elaborates
on the term common law employee for FICA purposes.
(c) Common law employees. (I) Every individual is an
employee if under the usual common law rules the relationship
between him and the person for whom he performs services
is the legal relationship of employer and employee.
(2) Generally such relationship exists when the person
for whom services are performed has 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. That
is, an employee is subject to the will and control of the
employer not only as to what shall be done but how it shall be
done. 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 he has the right to do so.
The right to discharge is also an important factor indicating
that the person possessing that right is an employer. Other
factors characteristic of an employer, but not necessarily
present in every case, are the furnishing of tools and the
furnishing of a place to work, to the individual who performs
the services. In general, if an individual is subject to the
control or direction of another merely as to the result to be
accomplished by the work and not as to the means and methods
for accomplishing the result, he is an independent contractor.
An individual performing services as an independent contractor
is not as to such services an employee under the usual common
law rules. Individuals such as physicians, lawyers, dentists,
veterinarians, construction contractors, public stenographers,
and auctioneers, engaged in the pursuit of an independent
trade, business, or profession, in which they offer their
services to the public, are independent contractors and not
(3) Whether the relationship of employer and employee
exists under the usual common law rules will in doubtful cases
be determined upon an examination of the particular facts of
each case. (Emphasis added)
The FICA Regulation pertaining to the common law definition of
an employee states that an individual is an employee for FICA
purposes if a legal relationship of employer and employee exists
under the usual common law rules. The legal relationship of employer
and employee generally exists when the following factors are pre-
sent: (1) the right to control and direct the individual who
performs the services, (2) the right to discharge, and (3) the
furnishing of tools and a place to work by the employer.
Treasury Regulation Section 31.3121(d)-l(c) further states
that an individual performing services as an independent contractor
is not considered a common law employee. Instead of defining
factors that are characteristic of an independent contractor, the
Regulation simply gives examples of several professions that are
in the pursuit of an independent trade and who offer their services
to the public; such as, lawyers, physicians, dentists, etc. Finally,
the Regulation states that determining an employer-employee rela-
tionship under the usual common law rules is a question of fact
and must be determined for each case individually.
While Section 3121(d) and its corresponding Treasury Regulation
provide some elaboration on the definition of a common law employee
for FICA purposes, the incompleteness of the statutory authority is
evident by the substantial amount of litigation in this area.103
It has been left largely to the courts to determine when a common
law employer-employee relationship exists within the broad guidelines
contained in Section 3121(d) and Treasury Regulation Section 31.3121
For FUTA purposes, Section 3306(i) states that "the term
employee has the meaning assigned to it by Section 3121(d), except
that subparagraphs (B) and (C) of paragraph (3) shall not apply."
This means that with the exception of certain types of home workers
and full-time insurance sales persons, the FICA and FUTA definition
of employees are identical.
For the withholding of income taxes, Section 3401(c) simply
For purposes of this chapter, the term "employee" includes
an officer, employee, or elected official of the United
States, a State, or any political subdivision thereof,
or the District of Columbia, or any agency or instru-
mentality of any one or more of the foregoing. The term
"employee" also includes an officer of a corporation.
The Treasury Regulations for Section 3306(i) and 3401(c) are
substantially the same as the FICA Regulations already reproduced
above and consequently need not be included. So even though
Section 3401(c) does not mention common law employee specifically,
the Section 3401 regulation that defines employee is synonomous
with the other regulations that do define a common law employee
for FICA purposes.
While "employee" has not been defined for income tax
withholding purposes as any particular type of "employee,"
the authorities have merely assumed, sub silentio in
most cases, that the word "employee" as used in the income
tax withholding statutes means "common law employee".
Because of this historical treatment of the income tax
withholding provisions and, further, because the statu-
tory scheme would seem to support such an inference, it
may be inferred that an "employee" for income tax with-
holding purposes means a "common law employ e", as that
phrase is defined in the FICA regulations.'0
Consequently, under the current employment tax provisions,
when a taxpayer, an administrator, or a court is trying to determine
if an employer-employee relationship actually exists, unless
specifically exempted by the statutes, such a determination must
be decided under the common law rules. In litigation, the court
generally consolidates the FICA, FUTA, and income tax withholding
issues into one question and that is whether or not the worker is
an employee of the plaintiff under the common law rules (Treas.
Reg. Section 31.3121(d)-(1)(c)(3)).
Revenue Act of 1978
With the increased enforcement of the employment tax laws
by the IRS, many taxpayers have complained that proposed reclas-
sifications of their workers represent a change in the IRS's
position.05 Some taxpayers have relied on private letter rulings,
technical advice memoranda, and results of prior audits for deter-
mining employment status but nevertheless have found themselves the
subjects of reclassifications by the Service.06 Congress found
it appropriate to provide interim relief to taxpayers involved in
employment tax status conflicts with the IRS until it had adequate
time to resolve the issue. As a result, Section 530 of the
Revenue Act of 1978 was enacted to provide relief for the 1979
tax year. Congress was unable to resolve the employment tax
status issue during 1979, so H.R. 5505 extended the relief pro-
visions of Section 530 until the end of 1980.1
In general, Section 530 accomplishes two primary objectives.
First, Section 530(a)(1) provides that if the taxpayer did not
treat an individual as an employee for any period ending before
January 1, 1980, and all necessary Federal tax returns were cor-
rectly filed in 1979, then the individual will not be treated as
an employee unless there is no reasonable basis for such treatment.
Section 530(a)(2) stipulates that a reasonable basis exists for not
treating a worker as an employee regardless of the circumstances
if the taxpayer has relied on any of the following:
(1) judicial precedent, published rulings, technical
advice with respect to the taxpayer, or a letter
ruling to the taxpayer,
(2) a past Internal Revenue Service audit of the tax-
payer in which there was no assessment attributable
to the treatment (for employment tax purposes)
of the individuals holding positions substantially
similar to the position held by this individual, or
(3) long-standing the recognized practice of a signifi-
cant segment of the industry in which such individual
Second, Section 530(b) prohibits the Treasury Department from
publishing any Regulation or Revenue Ruling after the enactment of
the Revenue Act of 1978 (November 6, 1978) dealing with the employ-
ment status of any individual for purposes of employment taxes.
With the interim relief provided by Section 530 (and extended
by H.R. 5505), Congress has had time to consider many suggestions
as to the remedies for the complex issues that beset the employment
tax area. The next section of this study will briefly introduce
the principal recommendations that have been presented to Congress.
Current Proposed Solutions
General Accounting Office
The General Accounting Office (GAO), at the request of the Joint
Committee on Taxation, conducted a study of the problems with ad-
ministration of the social security tax and the definition of a
common law employee.0 In reviewing the problem of classification
of workers as employees or independent contractors, the GAO con-
cluded that the principal problem involved uncertainty in the
application of the common law control rules. Numerous examples
were discovered where the IRS is inconsistently applying the common
law rules in different geographical areas.ll The GAO report
states that the "major cause of the employee/self-employed contro-
versy involves those cases in which the reclassified workers operate
a business separate from the one that the IRS considers to be the
The primary recommendation of the GAO is that a clear cut test
needs to be devised to introduce a greater degree of certainty
into the employment tax area for both the taxpayer and the IRS.
The approach taken by the GAO is to use four basic tests in deter-
mining whether a true separate business entity actually exists.
If a worker can satisfy the following four tests, the IRS will
be prohibited from reclassifying the worker as an employee. The
(1) Have a principal place of business other than that
furnished by the person or persons for whom he or
she performs or furnishes services;
(2) Maintain a separate set of books and records that
reflect all items of income and expense of his or
her trade or business;
(3) Bear the risk of suffering a loss and the oppor-
tunity of making a profit; and
(4) Hold himself or herself out in his or her own name
as self-employed and/or makes his or her services
generally available to the public.
The report argues that the four tests are "more precise, easier to
understand, and can be applied more accurately and consistently
than the common law rules."3 However, failure to meet all four
criteria will not result in automatic employee status. Instead,
if the worker satisfies three of the four criteria this will still
be a possible indication of self-employment and such a situation
will revert to the regular common law rules. If only two of the
four criteria are satisfied, then the worker will be presumed to
be an employee. The GAO concludes that the number of cases that
will require litigation to determine common law employee status will
be greatly reduced by this type of an approach.
In addition to the tests, the GAO proposal prohibits retro-
active determinations (in absence of fraud) if a business (1) obtains
annually from the individual whom the business classifies as self-
employed a signed certificate stating that the individual meets
all the separate business entity tests, and (2) annually provides
the IRS with the name and employer identification number or social
security number of each such certificate signer. To increase the
effectiveness of these criteria the report also proposes that the
taxpayer should sign the certificate under penalty of perjury.
Another problem perceived in the GAO study is the problem of
double collection of taxes on the same income as mentioned in the
introduction of this study. The GAO report proposes that the IRS
amend Section 6521 to allow an offset against the employees' por-
tion of the FICA tax by the appropriate portion of the SECA tax
already paid by the worker.114
H.R. 3245; Safe Harbor Remedy
A similar approach to the GAO proposal was introduced by
Representative Gephardt on March 27, 1979, as H.R. 3245. The
overriding purpose of this bill is to preserve the independent
contractor status of workers in industries that have traditionally
enjoyed such status and are currently being reclassified by the
IRS. This bill, like the GAO proposal, does not replace the
common law rules. Those workers who can not satisfy the five
"safe harbor" criteria for independent contractor status will
then come under the common law rules.
The five safe harbor rules are similar to several of those
proposed by the GAO.
(1) An independent contractor must control the hours he
works. This rule implies a two pronged test. The
worker must control not only the aggregate number of
hours actually worked, but he also must control
substantially all the scheduling of the hours worked.
(2) Independent contractors provide their own place of
business. Renting from the person for whom the
worker provides services would not be prohibited
as long as the rent is reasonable.
(3) An independent contractor experiences investment
or income fluctuations. His compensation is neither
fixed nor guaranteed. Substantial investments
in assets introduce the risk of business failure
and again this is a characteristic of self-employment.
(4) The worker, as an independent contractor, must
perform services pursuant to a written contract
that spell out the employment status and the tax
consequences that result. This test is fairly
mechanical, but it alerts both parties to their
relationship for both business and tax purposes.
(5) The person for whom the services are provided must
file the required tax returns. The worker must re-
ceive the necessary information to file his tax
returns and the IRS must receive the necessary
information to permit collection of the taxes due.
The satisfaction of the five safe-harbor criteria by a worker
would result in automatic independent contractor status. If the
criteria could not be satisfied then the worker would fall under the
usual common law rules. This notion is corroborated by Rep. Gcphardt
in the following summary of the purpose and application of H.R.
This bill creates a statutory scheme that promises to
end the confusion and uncertainty created by IRS enforce-
ment practices that have characterized employment tax
status determinations for nearly a decade. It is re-
cognized, however, that the tests cannot govern all
cases. Therefore, if any one of the tests is not met,
the common law test will be applied to determine the
worker's status as an independent contractor or an
Department of the Treasury
The Treasury's principal arguments against the GAO and
Gephardt proposals are that
(1) the taxpayer will be able to manipulate the tests
simply by changing the form of the business relation-
ship without changing the substance,
(2) the tests are unclear and difficult to administer,
(3) the proposals would continue the need for the use
of the common law rules in many situations, and
(4) the Service does not feel that the proposals will
deter the large number of independent contractors
who willfully fail to comply with the employment tax
However, the solutions offered by the Treasury take an entirely
different approach to the situation because they view the primary
problem as one of noncompliance.9 This assessment of the problem
is largely due to a recent study conducted by the IRS where they
concluded that 47 percent of the workers treated as independent
contractors failed to declare any of their compensation for income
tax purposes and 62 percent paid none of the social security tax due.
Since the Treasury considers noncompliance of independent
contractors as the most serious problem, their solutions have nothing
to do with the definitional aspects of the common law rules.
Instead, the Treasury supports a flat 10 percent withholding on
compensation paid to independent contractors. This aids in the
collection process for the IRS and also provides more information
with which they can monitor independent contractors and the taxes
they should be paying. In addition to the 10 percent withholding,
the Treasury Department has proposed that instead of a one dollar
penalty per information return not filed (with a maximum penalty
of $1,00), that the penalty should be increased to 5 percent of
payments not reported (with a $50 minimum penalty).121
An interesting note to the Treasury proposal is that the
taxpayer who is paying a worker must still determine if he is an
employee and subject to the graduated withholding requirements
or if he is an independent contractor and subject to the flat
10 percent withholding requirements. The issue of noncompliance
is obviously an important concern, but the fundamental problem that
still remains is the need to differentiate between an independent
contractor and an employee.
The fact that both noncompliance and the lack of certainty
with the employee definition are important problems is manifest
in the compromise bill, H.R. 5460, that was submitted to the
House Ways and Means Committee shortly before the end of 1979.1
Briefly, the compromise bill incorporated the five safe harbor
criteria that are contained in H.R. 3245 and the flat 10 percent
withholding from compensation paid to independent contractors
as proposed by the IRS. The only exceptions to the 10 percent
withholding requirements are that no withholding need occur from
a person who (1) performs similar services for five or more
unrelated service-recipients; or (2) certifies that withholding
would be excessive; or (3) makes direct sales for a supplier who
provides no renumeration other than a volume sales bonus.123
Therefore, unless a person qualifies under one of the above excep-
tions, regardless of a person's employment status some sort of
withholding will be applied to any compensation received. Until
this or similar legislation is enacted, the relief provisions of
Section 530 of the Revenue Act of 1978 will continue to be in force
awaiting Congressional enactment of permanent legislation in the
employment tax area.
IJ. HUGHES, THE FEDERAL SOCIAL SECURITY TAX 1 (1941).
3R. COMPTON, THE SOCIAL SECURITY PAYROLL TAXES 4 (1940).
4Social Security Act of 1935, ch. 531, 49 Stat. 620 (1935).
5U.S. v. Silk, 67 S.Ct. 1463 (1947).
R. COMPTON, supra note 3, at 129.
7Who Are Employees, Title 26 C.F.R. Sec 401.3 (1939) and
Employed Individuals, Title C.F.R. Sec. 400.205 (1939).
9R. COMPTON, supra note 3, at 130.
1F. MAITLAND & F. MONTAGUE, A SKETCH OF ENGLISH LEGAL HISTORY
C. KINNANE, ANGLO-AMERICAN LAW 284 (2nd edition, 1952).
I2d. at 281.
1Id. at 471.
20Id. at 281.
2F. POLLOCK & F. MAITLAND, THE HISTORY OF ENGLISH LAW, vol.2,
p. 528 (1911).
22Singer Manufacturing Co. v. Rohn, 132 U.S. 518 (1899).
Id. at 521.
24Id at 518.
2d. at 524.
2615 Wall. 649, 656 as cited in Singer Manufacturing Co.,
supra note 22, at 523.
27Metcalf & Eddy v. Mitchell, 269 U.S. 514 (1925).
2Id. at 521.
See fn. 18 in J. HUGHES, supra note 1, at 48.
30Hearings Relative to the Social Security Act Amendments of
1939 Before the Committee on Ways and Means, 76th Cong., 1st Sess.
8, 11 (1939) (statement of Arthur J. Altmeyer).
2SH.R. NO. 728, 76th Cong., 1st Sess. 61-62 (1939).
33Id. at 74.
34S.REP. NO. 734, 76th Cong., st Sess. 75 (1939).
S.REP. NO. 734, 76th Cong., Ist Sess. 75 (1939).
3Sections 1400-1432 (Subchapter A), Chapter 9, Internal Revenue
Code of 1939.
3Sections 1600-1611 (Subchapter C), Chapter 9, Internal Revenue
Code of 1939.
37Smith, Independent Contractor or Employee?--That is the Ques-
tion, 33 NEW YORK UNIVERSITY INSTITUTE ON FEDERAL TAXATION 581 (1975).
38S.REP. NO. 1631, 77th Cong., 2d Sess. (1942).
I3d. at 8.
40Hearings on Revenue Revision of 1942 Before the Committee on
Ways and Means, 77th Cong., 2d Sess. 81 (1942) (statement of Randolph
41H.R. NO. 2333, 77th Cong., 2d Sess. 14-15 (1942).
Id. at 125.
43Id. at 127.
44Id. at 127-128.
45S.REP. NO. 1631, supra note II, at 165.
46H.R. NO. 2586, 77th Cong., 2d Sess. 56 (1942).
47H.R. NO 510, 78th Cong., Ist Sess. 30 (1943); Current Tax
Payment Act of 1943, ch. 120, par. 2, 57 Stat. 126 (1943).
4U.S. v. Silk, 67 S.Ct. 1463 (1947); Harrison v. Greyvan
Lines, Inc., 67 S.Ct. 1463 (1947); and Bartels v. Birmingham,
67 S.Ct. 1547 (1947).
49U.S. v. Silk, supra note 5, at 1465.
Id. at 1466.
56Id. at 1470
5Id. at 1471.
See previous discussion dealing with the Social Security
Act Amendments of 1939 and the introduction to the income tax
62U.S. v. Silk, supra note 5, at 1467,1472.
63d. at 1469.
667 S.Ct. 1547 (1947).
66Id. at 1548.
Id. at 1551.
72d. at 1550.
74322 U.S. Ill (1944).
76Id. at 124,129.
7U.S. v. Silk, supra note 5, at 1468.
712 Fed. Reg. 7966-69 (1947) as cited in Smith, supra note
37, at 584.
8H.R. NO. 1319, 80th Cong., 2d Sess. 3 (1948).
82Id. at 304.
83Act of June 1, 1948, Pub. L. No. 80-642, ch. 469, 62 Stat.
84S.REP. NO. 1255, 80th Cong., 2d. Sess. 11 (1948).
85Act of June 1, 1948, supra note 83, at 438.
86North, The Employment Tax Morass, 11 CREIGHTON LAW REVIEW
87See fn. 2 in Bonney Motor Express v. U.S., 10 AFTR 2d 5233
(E.D. Va. 1962).
88Hearings on H.R. 2893 Before the Committee on Ways and
Means, 81st Cong., Ist Sess. 1087-1088 (1949).
8H.R. NO. 1300, 81st Cong., Ist Sess. 14-15 (1949).
Id. at 81.
91S.REP. NO. 1669. 81st Cong., 2d Sess. 95-97 (1950).
92Social Security Act Amendments of 1950, Pub. L. No. 81-734,
ch. 809, Sections 104(a) and 205(a), 64 Stat. 500,536 (1950).
93Id., Sections 211-213, at 502.
9426 U.S.C. Sections 480-482, pp. 3556-3558 (1952).
95Id., Section 480, at 3557.
961d., Section 481(b), at 3557-3558.
97Id., Section 481(c), at 3558.
981d., Section 23(a)(1)(A), at 3295.
99Id., Section 481(c)(3), at 3558.
100Compare the language of Sections 1401-1403 of the 1954
Code with Sections 480-482 of the 1939 Code.
1010utside of the employment tax area, the notion of employee
can become equally confusing. For example, the benefits of deferred
taxation of income were extended to self-employed individuals
through the Keogh or H.R. 10 plans. For purposes of qualified
pension, profit-sharing, or stock bonus plans, a shareholder-
employee of a Subchapter-S corporation is interestingly not treated
as an employee, but rather is subject to the limitations imposed
on the self-employed retirement plans Section 401(a)(17) On
the other hand, partners who are treated as self-employed persons
for purposes of retirement benefits may be treated as employees
for purposes of Section 119 (exclusion from gross income for meals
and lodging provided to an employee for the convenience of the
employer) according to Armstrong v. Phinney, 394 F. 2d 661
(5th Cir. 1968).
02Marmoll, 'Employee Defined', TAX MNGM'T (BNA) No. 391,
p. A-3 (1979).
0For an example of the numerous cases litigated in this
area see Marmoll, supra note 102, at C-6 through C-10.
0Marmoll, supra note 102, at A-5.
5S.REP. NO. 1263, 95th Cong., 2d Sess. 210 (1978).
JOINT COMMITTEE ON TAXATION, ISSUES IN THE CLASSIFICATION
OF INDIVIDUALS AS EMPLOYEES OR INDEPENDENT CONTRACTORS 8 (1979).
S.REP. NO. 1263, supra note 105.
0Revenue Act of 1978, Pub. L. No. 95-600, Sec. 530, 92
Stat. 2885 (1978).
0Act of December 29, 1979, Pub. L. No. 96-167, 93 Stat.
10GENERAL ACCOUNTING OFFICE, TAX TREATMENT OF EMPLOYEES AND
SELF-EMPLOYED PERSONS BY THE INTERNAL REVENUE SERVICE: PROBLEMS
AND SOLUTIONS 2 (1977).
IIId. at 9.
1Id. at 19.
SId. at 21.
4Id. at 45.
15H.R. NO. 3245, 96th Cong., 1st Sess., 125 CONG. REC. E1342
(daily ed. March 27, 1979) (remarks of Rep. Gephardt).
1125 CONG. REC. H2140 (daily ed. April 9, 1979) (remarks
of Rep. Gephardt).
117Id. at H2142.
Hearings on H.R. NO. 3245 Before the Subcommittee on Select
Revenue Measures, 96th Cong., Ist Sess. 5 (1979) (statement of
19Id. at 7.
10d. at 14.
Id. at 12.
H.R. NO. 5460, 96th Cong., Ist Sess., 125 CONG. REC. H8769
(daily ed. September 28, 1979) (remarks of Rep. Rostenkowski).
23Id. at H8774.
Research Question 1
The purpose of Research Question 1 is to identify those factors
or variables that are relevant in determining whether or not a
worker is a common law employee. Once these factors are identified,
the court cases can be examined to determine which factors were
mentioned by judges in their written opinions. These data will then
be used to build the models needed to answer the remaining three
The first source of relevant factors was contributed by the
appropriate statutory authority. To supplement the limited
statutory guidelines a literature review was conducted. The most
significant work in the common law employee area as far as identify-
ing relevant definitional factors was a BNA Tax Management port-
folio.2 The Tax Management portfolio heavily cited both the IRS
audit manual3 and the Restatement of Agency (hereinafter referred
to as the Restatement). Consequently, these two sources were
studied in detail and are relied on heavily in the subsequent ex-
planation and definition of the variables.
Operational Definition of Variables.
The following is a list of the variables that were obtained
from the above mentioned sources. Each of these eleven variables
is discussed in detail in the pages that follow.
3. Right to delegate.
4. Continuing relationship.
5. Set hours of work.
6. Having control over the place of work.
7. Independent trade.
8. Method of payment.
9. Payment of business and/or travel expenses.
10. Furnishing of tools and materials.
11. Realization of profit or loss.
1. Supervision. Supervision as defined in this study,
centers on the ability of a would be employer to control "how"
a worker accomplishes his assignment. Even though it does not use
the term supervision, Treasury Regulation Section 31.3121(d)-l(c)(2)
states that a common law employee relationship generally "exists
when the person for whom services are performed has 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"
The IRS audit manual discusses supervision in terms of three
separate criteria. The first criterion is referred to as
instructions and is defined as--
A person who is required to comply with instructions
about when, where, and how he is to work is ordinarily
an employee. Some employees may work without receiving
instructions because they are highly proficient and
conscientious workers. The instructions which show how
to reach the desired result may be oral or written.5
The IRS definition of instructions closely parallels the earlier
definition of supervision taken from the Treasury Regulations. Both
sources refer to the notion that an employer is concerned with
more than simply the end results of a job. Instead,an employer
generally desires to control how the job is to be performed. The
IRS definition also relates the need for supervision to the amount
of skill the worker possesses. This same point is made in Ben v. U.S.6
where the District Court stated that "the element of freedom from
control in the manner of the performance of the work, emphasized
in some decisions, loses much of the significance when the skill
of the worker is relied upon in the accomplishment of the par-
The second criterion is referred to by the IRS as training and
is defined as--
Training a person by an experienced employee working with
him, by correspondence, by required attendance at meet-
ings, and by other methods indicates that the employer
wants the services performed in a particular method or
manner. This is especially true if the training is given
periodically or at frequent intervals. An independent
contractor ordinarily uses his own methods and receives
no training from the purchaser of his services. In fact,
it is usually his methods which bring him to the attention
of the purchaser.8
If the employer requires an individual to attend meetings or work
with an experienced employee, this is further evidence of a desire
to control how the work is to be accomplished. In McCombs v. U.S.,
salaried supervisors were employed to observe workers who had
contracted to apply aluminum siding to residential housing. The
purpose of the supervisor was to "instruct the workers in certain
techniques and procedures" and "train people who had no previous
experience. The Court of Claims held that implicit in this find-
ing is the desire of the plaintiff to control not only the result
but also the manner of achieving it."l0
The ability to "direct the order or sequence in which the work
must be done" is the third criterion used by the IRS that relates
directly to the supervision factor. This criterion is defined
in the IRS audit manual as--
If a person must perform services in the order or sequence
set for him by the employer, it shows that the worker
is not free to follow his own pattern of work but must
follow the established routines and schedules of the em-
ployer. Often, because of the nature of an occupation,
the employer either does not set the order of the services
or sets them infrequently. It is sufficient to show
control, however, if he retains the right to do so.11
Again, the reasoning is that if a purchaser of someone's services
is able to control the order or sequence that must be followed by
the worker, then such an individual is controlling the details of
how the job is to be accomplished and is assuming an employer role.
The home improvement industry is an example of how the super-
vision factor has been applied in deciding employee versus indepen-
dent contractor cases. A firm hires salesmen to solicit home
repair jobs. As the jobs are acquired, an "applicator" is given
the job of affixing the roofing or siding materials. The question
is the applicator's employment status. The home improvement
company generally has supervisors to keep track of the applicators
progress and make sure the customers are satisfied with the com-
pleted job. The court has the task of determining the degree of
control these supervisors have exercised over the applicators.
In certain situations the supervisor only appears at the job site
to verify progress and offer advice if it is solicited.1 In
these cases, the courts have held that the lack of supervision
tends to support an independent contractor finding.13 On the other
hand, some courts have held that the supervisors had significant
control over the applicators and through considerable training and
instruction by the supervisors these workers become competent
applicators. In such cases, the courts held that the presence
of supervision supported an employee finding.15 Security Roofing and
Construction Co. v. U.S.16 discounted the notion that supervision
is an important factor when the work is largely routine.
Although it is true that the applicator is normally
unsupervised, he is checked on from time to time . .
If he needs instruction, as, for instance, in how to
conserve material, he receives it. After this, the
work being largely routine, supervision is unnecessary.
I do not regard its absence of controlling significance.
One can be an employee even though he supervises himself
as to the details.17 (Emphasis added)
The presence or absence of supervision is a determination of fact
that must be made by the trier of fact and is often a difficult
distinction to make.
The Restatement defines the overall test that should be
applied in determining a master-servant relationship is whether
"a person employed to perform services in the affairs of another and
who with respect to the physical conduct in the performance of the
services is subject to the other's control or right to control."l8
However, the Restatement then lists "the extent of control which,
by agreement, the master may exercise over the details of the work"
as one of the criteria to be used in applying the above described
test.19 It appears that the Restatement considers control of the
physical conduct of the worker as the overall test to be used in
determining employment status while it also considers control over
the details of the work to simply be one of the factors to be
looked at in applying the overall test. This apparent dual role
is somewhat confusing and is reasonably similar to the question
that surrounded the economic reality test.20 The economic reality
test attempted to relegate control from the overall test that should
be applied in determining a common law employee to a lesser role
as simply a single factor out of many that would be used in de-
fining employment status.
2. Integration. Whether the services performed by a worker
are an integral part of the business is closely related to the
independent-trade factor, variable number seven, to be discussed
later. However, the IRS audit manual treats integration as a
Integration of the person's services into the business
operations generally shows that he is subject to direction
and control. In applying the integration test, first
determine the scope and function of the business and
then whether the services of the individual are merged
into it. When the success or continuation of a business
depends to an appreciable degree upon the performance
of certain services, the people who perform those services
must necessarily be subject to a certain amount of control
by the owner of the business.21
A worker is considered to be a integral part of the taxpayer's
business if the services performed by the worker have "been molded
into he taxpayer's s overall business as one integrated operation
into the taxpayer's overall business as one integrated operation.
A contra example to the notion of being integrated into the business
is found in Aparacor v. U.S.23 which is a case dealing with the
employment status of commission salespersons or distributors.
Aparacor was a large corporation in the business of designing
and selling women's apparel which contracted with various indivi-
duals to distribute and sell its products at retail prices. The
distributors furnished their own office facilities, hired their
own assistants, and were free to engage in other work or the sale
of other products. They were neither reimbursed for expenses nor
trained by Aparacor. The Court further held that the retail dis-
tribution performed by the salespersons was not part of Aparacor's
"regular business of designing and supplying merchandise."24
Aparacor was distinguished from the cases relied on by the IRS
because the court held that those cases involved "typical (albeit
temporary) master servant relationships, that is, the performance
of relatively simple labor, in the course of and as an integral
part of the employer's business."25
Entertainers are an example of individuals that have been held
to be an integral part of the business for which they perform their
services.26 One Court relied on the fact that before certain belly
dancers were featured as part of the lounge show entertainment, the
business had been losing money.27 After the belly dancers and
Greek music were added the establishment became very profitable.
In a similar case, another Court held that go-go dancers were an
integral part of the business.28
The Court finds that the evidence does not support the tax-
payer's contention that the entertainment provided by
these individuals was merely ancillary and subordinate to
the main business. On the contrary, we must conclude that
the go-go dancers were an integral part of the business.29
In some situations, integration is considered an important
factor in employment status cases. However, in the 139 cases
(since several of the cases had multiple verdicts, the total
number of decisions rendered was 148) used in this study, inte-
gration was not explicitly mentioned in 120 of the decisions.
In twenty-six decisions integration was specifically mentioned
in favor of an employee finding and in only two decisions was the
lack of integration mentioned in favor of an independent contractor
finding. It appears that generally the integration factor either
does not apply to the situation or it is a difficult factor to
apply. A businessman is generally not going to hire a worker
to perform services that are unnecessary to the successful run-
ning of his business. To determine if workers are an integral
part of the business is a fact judgment that must be made by the
court. Only where a court explicitly mentions integration in a
written opinion is it considered as evidence supporting either
an employee or independent contractor finding for purposes of this
3. Right to Delegate. If a worker is able to hire, pay, and
fire his own helpers this evidences a certain degree of freedom
characteristic of an independent contractor. On the other hand,
an employer-employee relationship is generally indicated if a
worker is unable to delegate work to another person, or if the
purchaser of his services controls the hiring and firing of as-
The IRS audit manual defines the "right to delegate" in terms
of the freedom to "employ assistants." The right to delegate is
defined in the manual as--
If the services must be rendered personally, presumably
the employer is interested in the methods as well as
the results. He is interested in not only the result
but also the worker.30
The ability of a worker to employ his own assistants is
defined in the IRS audit manual as--
Hiring, supervising, and paying assistants by the employer
generally shows control over the men on the job. Some-
times one worker may hire, supervise, and pay the other
workmen. He may do so as the result of a contract
under which he is responsible for only the attainment
of a result. In this case he is an independent contrac-
tor. On the other hand, if he hires, supervises, and pays
workmen at the direction of the employer, he may be
an employee acting in the capacity of a foreman for or
representative of the employer.31
The Internal Revenue Code is not specific about what consti-
tutes a common law employee. For FICA and FUTA purposes, Section
3121(d) states that an individual is an employee under the usual
common law rules if the contract of service contemplated that sub-
stantially all of such services are to be performed personally
by such individual. This "if" clause seems to imply that it is not
enough for a person to be adjudged a common law employee, but
in addition the contract must contemplate that the services be
performed personally by the worker in question. Thus, according
to this statutory construction, the FICA withholding and payment
requirements cannot be applied to a common law employee unless
the right-to-delegate factor is first satisfied. It is interesting
to note that even though this statutory construction exists no
argument was ever made in the 139 cases included in this study to
avoid the FICA requirements due to the fact that the contract
involved contemplated personal performance of the services. Marmoll
concludes that "there has been a tendency in the authorities to
de-emphasize--primarily through silence--the statutory exceptions
set forth in Section 3121(d)."32
The presence or absence of the right-to-delegate factor was
a factor that was reasonably easy to elicit from the cases read.
Of the 148 judgements made by the District Courts and Court of
Claims, ninety-three decisions incorporated the ability to delegate
by the worker as a factor in favor of an independent contractor
finding. An additional fifteen decisions determined that the worker
did not have the freedom to delegate work or hire his own assis-
tants which tended to indicate an employer-employee relationship.
In the remaining forty decisions the right-to-delegate factor
was not relevant, or its effect was not determinable by the courts.
4. Continuing Relationship. In general, this factor supports
an employer-employee finding if the relationship between the
prospective employer and the worker is found to be of a permanent
nature. Exactly what factors must be present to constitute a
permanent relationship is not easy to pinpoint from the statutory
law or cases.
The Restatement's explanation of this factor is rather cursory.
"If the time of employment is short, the worker is less apt to
subject himself to control as to details and the job is more
likely to be considered his job than the job of the one employing
him."33 The problem with this definition is that it does not give
adequate guidance as to what should be considered permanent em-
ployment. If a worker performs services on a sporadic job-by-job
basis with no one job lasting over a few days, is this then
considered a non-permanent relationship? If this sporadic type
of relationship continues for several years does this then indi-
cate a continuing relationship? If the relationship is contractual
by nature, how long must the contract extend for a permanent rela-
tionship to exist? These are all questions that can arise when
attempting to use the continuing-relationship factor to aid in
determining an employee versus independent contractor case.
The IRS audit manual defines this factor as--
A continuing relationship between an individual and the
person for whom he performs services is a factor which
indicates that an employer-employee relationship exists.
Continuing services may include work performed at fre-
quently recurring though somewhat irregular intervals
either on call of the employer or whenever the work
is available. If the arrangement contemplates continuing
or recurring work, the relationship is considered per-
manent even if the services are part-time, seasonal,or
of short duration.34
The IRS is fairly clear in its interpretation of how to handle
sporadic employment that lasts for a reasonable length of time.
Their view is upheld in Tapager v. Birmingham35 where the District
Court held that even though certain salespersons were part-time
workers because their relationship was regularly recurrent this
was an indication of an employer-employee relationship. The Court
defined the continuing-relationship factor as--
The relationship of an independent contractor generally
contemplates the obtaining of an agreed end and usually
contemplates the obtaining of that end within a stipu-
lated period of time. The relationship of employment
generally contemplates a continuous and indefinite
rendering of services which relationship is terminable
either at the option of the employer or employee without
This definition implies that if a definiteness as to the time of
the termination of the relationship exists, then a non-continuing
relationship exists and we have an independent contractor finding.
On the other hand, a continuing relationship or employee finding
is indicated by an indefiniteness as to the time of the termination
of the relationship.
A somewhat contrary finding to Tapager was indicated in
Silver v. U.S. This case involved the home improvement industry
and the classification of an applicator of roofing and siding
materials as an employee or independent contractor. The applicator
in question had performed several jobs during the three year period
under question. The Court held that "permanency of relationship
can hardly be said to exist or be a weighty element when each
obligation was of comparatively short duration and the worker was
free to accept or reject the offer of a new or similar obligation."38
Therefore, when services are performed sporadically, but over a
reasonable length of time, it is not completely clear how a court
will interpret this situation in terms of the continuing-relationship
It is interesting to note that while the continuing-relationship
factor is mentioned in various sources (Restatement, IRS audit
manual, and court cases), that none of these sources refer to any
statutory support for this factor. The continuing-relationship
factor is listed in Section 3121(d) as an exception to the ap-
plication of the FICA provisions to a common law employee. Para-
graph (d) states that if a person is adjudged a common law employee
and satisfies the "if clause" discussed in conjunction with factor
three (right to delegate), then such a common law employee will be
considered an employee for the FICA provisions "except . if the
services are in the nature of a single transaction not part of
a continuing relationship with the person for whom the services
are performed" (Emphasis added). The statute quite clearly
provides that a worker who is classified as a common law employee,
but whose services are not part of a continuing relationship is
excepted from the FICA withholding and payment requirements which
for all intents and purposes treats the worker as an independent
contractor. As was mentioned previously, the exceptions of Section
3121 have not been argued in the cases included in this study
and appear to be substantially ignored in the application of the
common law employee rules for FICA purposes.
For purposes of this study, the continuing-relationship
factor was fairly prevalent in the written opinions of the cases
read. In forty-seven decisions the absence of a continuing rela-
tionship was indicated which favored an independent contractor
finding. In an additional sixty-eight decisions the presence of
a continuing relationship was found to exist which favored an
employee finding. In the remaining thirty-three decisions the
courts did not mention the continuing-relationship factor in their
5. Set Hours of Work. The ability of a worker to set the
aggregate number of hours he will work and also determine when he
will work those hours is usually an indication of the independence
possessed by a self-employed person. Whether a person can control
the hours he works is generally a readily determinable fact. This
is somewhat evidenced by the fact that of the 148 decisions con-
sidered in this study, only eight times did the court fail to
consider setting the hours of work as a relevant factor in their
written opinion. In the other 140 decisions ninety-nine times
the ability to set one's hours of work was mentioned in favor
of an independent contractor finding while in the other forty-one
decisions the ability of the prospective employer to control the
hours worked was considered to favor a finding of employee status.
In regards to the ability to control the hours an individual
works, the IRS audit manual provides that--
The establishment of set hours of work by the employer is
a factor indicating control. This condition bars the
worker from being master of his own time, which is the
right of the independent contractor. If the nature of
the occupation makes fixed hours impractical, a require-
ment that the worker work at certain times is an element
In H.R. 3245 as proposed by Representative Gephardt, the first
of the "safe-harbor" provisions is controlling the hours worked.
In hearings before the subcommittee on Select Revenue Measures,
Representative Gephardt proposed that this factor contain a two-
prong attack.41 First, in order to satisfy the safe-harbor pro-
visions, a worker must be able to control the aggregate hours he
works. Second, the worker must also be able to control the
schedule upon which he works these hours. If a worker meets these
two requirements then a reasonable degree of freedom appears to
exist favoring an independent contractor finding.
The real crux of this factor that has been mentioned by both
the IRS audit manual and H.R. 3245 is that: if a worker can control
how much, when, and how hard he works, then this is a strong indi-
cation of self-employment. If on the other hand, a person has to
work a 9 to 5 job due to his employer's desire, then the worker
is not master of his own time.
6. Having Control Over the Place of Work. The general
premise of this factor is that independent contractors generally
provide their own place of business while an employee is provided
a place to work by his employer. This general distinction, however,
is somewhat of an oversimplification. There are certain kinds of
work that must be done on the employer's premises, but such work
need not be done by an employee. For example, an electrician
must come to the employer's place of business, but by no means
necessitates that the electrician is an employee.
The IRS audit manual defines controlling-the-place-of-work
Doing the work on the employer's premises in itself is not
control. However, it does imply that the employer has
control, especially when the work is the kind that could
be done elsewhere. A person working in the employer's
place of business is physically within the employer's
direction and supervision. The use of desk space and
telephone and stenographic services provided by an em-
ployer places the worker within the employer's direction
According to this definition, the Service's position seems to be
that a fairly strong indication of an employer-employee relation-
ship exists if a worker performs his services on an individual's
business premises. However, Marmoll suggests that the Service's
current position is that "furnishing a place of work and of
supplies--while factors to be considered in determining an employer-
employee relationship--are not alone sufficient to establish the
Controlling the place of work is a factor included in both
the GAO proposal and H.R. 3245. In the GAO proposal, the second
of the four basic tests which must be met to be guaranteed
self-employment status requires the worker to have a "principal
place of business other than that furnished by the persons for
whom he or she performs or furnishes services."44 As stated, this
test seems to eliminate anyone being automatically considered an
independent contractor if they happen to work on the employer's
premises. However, in further explanation of this test, the GAO
proposal states that the principal place of business can be rented
from the would be employer if the rent if fair and reasonable4 5
While the ability to rent from the individual to whom the services
are rendered seems to provide more flexibility, the GAO proposal
states clearly that using a person's own residence for the princi-
pal place of work will not satisfy this test.4
Providing one's own place of business is also the second
requirement of the safe-harbor criteria suggested in H.R. 3245.
However, the bill does recognize that certain individuals, by the
very nature of the services they perform, do not have places of
business and should not be held to this requirement.47 For example,
insurance agents, door-to-door salesmen, real estate agents, truckers,
and loggers do not perform their services at a single location.48
The notion of salesmen and truckers introduces another element
into controlling the place of work. It is possible that a salesman
may be required to work in a certain area and that truckers may be
required to drive certain routes. According to the IRS audit manual,
this type of situation is also evidence of controlling the place of
work. The IRS audit manual states that--
Control over the place of work is indicated when the
employer has the right to compel a person to travel a
designated route, to canvass a territory within a certain
time or to work at specific places as required. In
some occupations services must be performed away from
the premises of the employer, for example, employees
of construction contractors or taxicab drivers.5
In most situations, the place-of-work factor is fairly easy
to determine. This partially explains why it was chosen by both
the GAO and Representative Gephardt in drafting proposals that
would hopefully add certainty to the common law employee definition.
In the cases included in this study, the employer controlling the
place of work was mentioned seventy-seven times in favor of an
employee finding. In another forty-nine decisions, the worker
was determined to control the place of work which favored an inde-
pendent contractor finding. In only twenty-six decisions did the
courts consider the place-of-work factor irrelevant.
7. Independent Trade. Whether or not a worker is engaged
in an independent trade or business from the person for whom he
is providing services is a very fundamental element of the common
law control test used in defining employment status. The Restate-
ment lists as one of the facts to be determined in establishing
whether a worker is an independent contractor or employee "whether
or not the one employed is engaged in a distinct occupation or
In discussing common law employees, the Treasury Regulations
state that individuals performing services as independent contrac-
tors are not common law employees.52 As an example of these types
of individuals, the Regulation lists "physicians, lawyers, dentists,
veterinarians, construction contractors, public stenographers,
and auctioneers, engaged in the pursuit of an independent trade,
business, or profession . ."53 (Emphasis added). The entire idea
of an independent contractor is closely tied to the existence of
a separate or independent trade or business.
The GAO, in their report to the Joint Committee on Taxation
discussed in Chapter II, directed the employment status test at
determining whether a true separate business entity actually
exists.54 From this study, the GAO concluded that the major prob-
lem centered around those situations where the worker had a sep-
arate trade or business from the prospective employer, but the IRS
still reclassified the worker as an employee. Because of the
GAO's belief that many of these separate businesses should indeed
by treated as independent contractors, their proposal was structured
such that a trade or business not only had to exist, but that trade
or business had to satisfy four basic tests to be considered as
a self-employed entity.56
The IRS audit manual provides substantial detail in how to
determine if a worker is engaged in a separate trade or business.
The manual divides the independent-trade factor into the following
three separate categories:
(a) Can the individual providing the services work for
a number of firms at the same time?
(b) Does the individual make his services available to
the general public?
(c) Is the individual required to devote his full time
to the person for whom he performs the services?
The audit manual defines the separate categories as--
Working for more than one firm at a time. A person
who works for a number of persons or firms at the same
time is generally an independent contractor because he
is usually free from control by any of the firms. It
is possible, however, for a person to work for a number
of people or firms and be an employee of one or all of
Making service available to general public. The
fact that a person makes his services available to the
general public usually indicates an independent contrac-
tor relationship. An individual may hold his services
out to the public in a number of ways; he may have his
own office and assistants; he may hang out a "shingle"
in front of his home or office; he may hold business
licenses; he may be listed in business directories or
maintain business listings in telephone directories;
or he may advertise in newspapers, trade journals, maga-
Full time required. If the worker must devote his
full time to the business of the employer, the employer
has control over the amount of time the worker spends
working and impliedly restricts him from doing other
gainful work. An independent contractor, on the other
hand, is free to work when and for whom he chooses.
Full time does not necessarily mean an 8-hour day or a
5- or 6-day week. Its meaning may vary with the intent
of the parties, the nature of the occupation, and customs
in the locality. These conditions should be considered
in defining "full time."
Full-time services may be required even though not
specified in writing or orally. For example, to produce
a required minimum volume of business may compel a person
to devote all of his working time to that business; or
he may not be permitted to work for anyone else, and to
earn a living he necessarily must work full time.58
It is very difficult to identify the distinction between working
for more than one firm at a time and having to devote one's full time
to one employer. Simply stated, if a worker works for other emp-
loyers and is not required to answer to just one boss, a certain
degree of independence is shown which is consistent with being
self-employed. For example, this type of independence is charac-
teristic of a worker known as a "gypsy chaser." A gypsy chaser
is an individual who contracts with a truck driver to unload his
truck which may contain furniture, fruit, etc. Gypsy chasers
generally frequent truck stops and attempt to solicit jobs as
truckers enter the stop. Generally, a gypsy chaser is engaged by
many different truck lines in a single day and is not considered
to work full time for any one firm.59 The courts have generally
interpreted this as significant evidence in favor of an indepen-
dent contractor finding.6
The occupation of a telephone solicitor is an example of a
different situation where a worker performs services for one per-
son and is required to work a set number of hours per day. In
Lieb v. U.S., telephone solicitiors who worked for an exterminator
company were classified as employees by the IRS. Among other fac-
tors discussed by the Court was the fact that the solicitiors were
required to work their entire shift in the employer's office for
five or six days a week.62 Such a finding was evidence that the
basic relationship between the telephone solicitors and Lieb was
that of an employer-employee.
The distinction between working for more that one firm at
a time, or offering services to the general public, is also very
slight. The nature of the services performed by a worker apparently
determines whether an individual can provide his services to the
public at large, or whether he can provide his services to a number
of different firms, and thus whether an employer-employee relation-
ship exists. For example, a steel consultant's services are of
fairly limited application to the general public and would there-
fore probably be limited to certain engineering or steel-related
industrial firms. In contrast, an insurance salesman's services
are of the nature that are more applicable to the general public.
It is this type of service that the IRS audit manual is referring
to when it states that a worker may advertise in newspapers,
magazines, or be listed in the telephone directory. In reading
the court cases that comprise the data for this study, it was found
that working for more than one firm and working for the general
public measured the same basic factor, but simply applied in dif-
ferent factual situations.
The independent-trade factor was considered present in the
cases read for this study if it was manifest in any of the three
separate categories as defined by the IRS. In the majority of the
decisions (ninety-four), an independent trade or business was deter-
mined to exist. In twenty-five decisions the courts held that the
worker was not involved in a separate independent trade or bus-
iness. In the remaining twenty-nine decisions, whether or not
an independent trade existed was not a relevant factor according
to the court's written opinion or if it was relevant it was inde-
terminable whether or not it favored an independent contractor
versus an employee finding.
8. Method of Payment. The method of payment is the seventh
fact that the Restatement mentions should be considered in determining
whether "one acting for another is a servant or an independent con-
tractor."63 The Restatement fails to elaborate on what methods of
payment distinguish an independent contractor finding from an em-
ployee finding. The IRS audit manual's definition, however, is
quite helpful in adding some substance to this factor. The IRS
audit manual defines the method of payment as--
Payment by the hour, week or month generally points to
an employer-employee relationship, provided that this
method of payment if not just a convenient way of paying
a lump sum agreed upon as the cost of doing a job. The
payment by a firm of regular amounts at stated intervals
to a worker strongly indicated an employer-employee
relationship. The firm assumes the hazard that the
services of the worker will be proportionate to the
regular payments. This action warrants the assumption
that, to protect its investment, the firm has the right
to direct and control the performance of the worker.
It is also assumed in absence of evidence to the con-
trary that the worker, by accepting payment upon such
basis, has agreed that the firm shall have such right
of control. Obviously, the firm expects the worker to
give a day's work for a day's pay. Generally, a person
is an employee if he is guaranteed a minimum salary or
is given a drawing account of a specified amount at
stated intervals and is not required to repay any excess
drawn over commissions earned.
Payment made by the job or on a straight commission
generally indicated that the person is an independent
contractor. Payment by the job includes a lump sum
computed by the number of hours required to do the job
at a fixed rate per hour. Such a payment should not
be confused with payment by the hour.64
The explanation of the method-of-payment factor provided by the
IRS indicates that the basic distinction is that employees are
paid regular amounts at stated intervals regardless of the employee's
output, whereas an independent contractor is paid on a lump-sum
or per-job basis and his compensation does depend on his completion
of certain requirements.
This basic distinction makes sense when one assumes that if a
worker is to be paid by the hour his employer is interested in
the worker completing the task in the shortest reasonable amount
of time. Since the employer must pay such a worker by the hour,
he likely will provide more detailed instructions and supervision
to ensure the quickest possible completion of the job.
On the other hand, if the worker is paid by the job in a lump
sum payment, this tends to indicate that the purchaser of the
services is only interested in the final results to be accomplished.
The amount of time to complete the job is irrelevant in this type
of situation as long as the results are those that both parties
agreed upon. In fact, it would be incumbent upon the worker to
determine the quickest method to complete a job because his com-
pensation is directly related to the number of jobs that he can
successfully complete. Also, the fact that a worker may receive
payment in several installments before the job is completed is
not an indication of employer-employee relationship. According
to the IRS audit manual, if the receipt of intermittent payments
is merely a convenient method to disperse a lump sum, then such
an arrangement still favors an independent contractor finding.65
The rule that is being applied throughout the entire analysis of
this factor is whether the worker's compensation is contingent on
his performance of certain requirements (meaning no guarantee of
profit) or simply the number of hours he works.
In general, the determination of how a worker is paid is
rather straightforward. In the cases included in this study,
128 times the judge determined that the worker was being paid in
a method that indicated an independent contractor finding. In an
additional seventeen cases, the judges felt the method of payment
seemed to indicate an employer-employee relationship. In only
three cases was the method-of-payment factor not considered in the
judge's written opinion. From this it is evident that the method-
of-payment factor has been applied in most of the cases included
in this study and the information needed to apply this factor in
actual court case situations is usually readily available.
9. Payment of Business and/or Traveling Expenses. The
reimbursement of expenses is concerned in general with the
method-of-payment factor as discussed above, but is unique enough
to be considered a separate factor. Reimbursement of expenses has
a similar advantage to the method-of-payment factor; namely, it is
a reasonably simple factor to apply. Either a worker is being re-
imbursed for his business expenses or he is not. This is not
particularly consistent with the fact that in fifty-seven of the
decisions analyzed in this study, the court did not appear to
consider reimbursement of expenses in their written opinions.
This is most likely attributable to the fact that a reimbursement
of expenses was not mentioned specifically in the Restatement or
in one of the landmark cases as was the method-of-payment factor.66
This may result in the situation where reimbursement of expenses
is simply considered jointly with the method-of-payment factor as
does Marmoll in the Tax Management portfolio.67
This study takes the same approach as the IRS audit manual
by treating reimbursement of expenses as a separate factor. The
audit manual defines reimbursement of expenses as--
If the employer pays the person's business and/or traveling
expenses, the person is ordinarily an employee. The
employer, to be able to control expenses, must retain
the right to regulate and direct the person's business
Conversely, a person who is paid on a job basis and
who has to take care of all incidental expenses is
generally an independent contractor. Since he is account-
able only to himself for his expenses, he is free to work
according to his own methods and means.68
The audit manual implies that a worker who has to depend on an
employer for reimbursement of expenses is more subject to that
employer's control than is a worker who pays his own expenses.
In other words, reimbursement of a worker's expenses is simply
another method of controlling that worker's business activities.
An employer-employee relationship tends to be indicated when a
purchaser of services pays for the worker's business licences,
meals, transportation, or allows the worker to use the company's
The Service's position as discussed above is somewhat inflex-
ible. Marmoll states that--
The Service's position, as set forth in the manual, on
the payment of business or travel expenses ignores the
possibility of a cost plus fixed fee contract as well
as the modern day custom of charging itemized expenses
to the customer or client in addition to the fee for the
work done. The clients of lawyers and accountants, for
example, are customarily charged for the attorney's or
the accountant's travel expenses and, yet, the client
does not control the business activities of the attorney
or accountant, the relationship clearly being one of
client and independent contractor.69
The lawyer or accountant example above appears to suggest that the
reimbursement-of-expenses factor needs to be considered in terms
of the overall compensation agreement. If the reimbursement of
expenses is in addition to an agreed upon lump sum fee, then Mar-
moll seems to suggest that the lump sum payment which supports
an independent contractor finding somehow overrides the fact that
expenses are reimbursed which of course favors an employee finding.
While it is true that the method-of-payment factor may carry more
weight than the reimbursement-of-expenses factor when they have
conflicting results, the fact still remains that reimbursement
of expenses by the employer still favors an employee finding.
In the cases included in this study, judges were able to apply
the reimbursement-of-expenses factor on its own merits in ninety-
one decisions. In seventy-four of these decisions the factor
favored an independent contractor finding while in the other
seventeen decisions the factor favored an employee finding.
10. Furnishing of Tools and Materials. The more substantial
the investment in tools and materials by a worker, the more likely
the worker is to be considered an independent contractor. If the
employer furnishes the tools and materials necessary for the
accomplishment of the worker's assignments, then this tends to
indicate an employer-employee relationship. There are certain
kinds of jobs for which the tools needed to perform the assigned
task are inconsequential. For example, a gypsy chaser70 who unloads
trucks needs practically no tools to perform his services. Since
the work is primarily manual, the furnishing of tools would not
be a particularly significant factor in a case involving the
employment status of a gypsy chaser. On the other hand, an appli-
cator of siding and roofing materials must have a rather complete
set of hand tools, ladders, scaffolding, etc. and the furnishing
of tools would be a much more significant factor in this type of
Both Treasury Regulation Section 31.3121(d)-l(c)(2) and the
Restatement include the furnishing of tools as a factor that should
be included in the definition of a common law employee. The Restate-
ment further states that if the tools are provided by the employer
and are of substantial value, it is understood that the worker will
follow the directions of the owner in their use and this indicates
the owner is master.71 The IRS audit manual provides additional
detail as to how the furnishing-of-tools-and-materials factor
should be interpreted.72 The audit manual describes this factor
The fact that an employer furnishes tools, materials,
etc., tends to show the existence of an employer-emp-
loyee relationship. Such an employer can determine
which tools the person is to use and to some extent,
in what order and how they shall be used.
An independent contractor ordinarily furnishes his
own tools. However, in some occupational fields, e.g.,
skilled workmen, workers customarily furnish their own
tools. They are usually small hand tools. Such a prac-
tice does not necessarily indicate a lack of control over
the services of the worker.73
Application of the furnishing-of-tools-and-materials factor
is relatively straightforward which is evidenced by the fact that
in 131 out of 148 decisions included in this study the judges men-
tioned this factor in their written opinions. In eighty of those
decisions, the courts held that the worker provided his own tools
and/or materials which favored an independent contractor finding.
In another fifty-one decisions the courts held that the employer
provided the tools and/or materials which favored an employee finding.
In only seventeen decisions did the judges fail to discuss the fur-
nishing-of-tools-and-materials factor as part of their written
11. Realization of Profit or Loss. The worker who can realize
a profit or sustain a loss is generally an independent contractor
and the worker who is prevented from earning a profit in excess
of his stated compensation or is insulated against sustaining
losses, is generally considered an employee. For example, in
Nevin Inc. v. Rothensies the court held that a lessee of a drug-
store was an independent contractor. In this case, the parties
involved established a separate (though not a fully independent)
business where the lessee had a considerable personal financial
stake in the business.
He could make or lose money in the business. The pos-
sibility of profits could be enhanced by efficiency,
economy and skill. He took the risk of considerable per-
sonal loss in case the business was not successful a
risk which involved a good deal more than the mere
possibility of loss of position. He obtained complete
freedom in connection with his own time, working hours,
etc., and an opportunity to increase his income not only
by sales records (as in the case of a commission salesman)
but by business judgment in most of the matters which
are in the province of any independent retailer.75
Consequently, the lessee could affect the amount of profits he was
able to earn through his own managerial efficiency and skill.
The IRS audit manual also discusses the importance of managerial
skill in the realization of profits and avoidance of losses.76
The manual states that "whether a profit is realized or loss
suffered generally depends upon management decisions; that is,
the one responsible for a profit or loss can use his own ingenuity,
initiative, and judgment in conducting his business or enterprise."77
Another important component of the realization-of-profit-or-
loss factor is determining whether the worker has a significant
capital investment in the business. The IRS audit manual provides
that for a significant investment to exist, the investment must
be real, essential, and adequate.78 Such an investment is made
generally in equipment, furniture, or real property necessary to run
The question of whether an investment in equipment is real
seems to be concerned with whether the worker really has an equity
investment, or is the worker simply buying the equipment on time
from the person for whom he is providing services. The audit manual
illustrates this point in the following illustration.
Little weight can be accorded to a worker's investment . .
if the worker purchases equipment from his employer
on a time basis but the employer retains title to the
equipment, has the option of retaining legal ownership
by paying the worker the amount of his equity in the
equipment at any time before the equipment is fully paid
for, requires its exclusive use in the operation of
his business, and directs the worker in its use. Such
investments are not "real".79
To be essential the investment must be in equipment or facil-
ities necessary for the performance of the worker's services.
The example given in the IRS audit manual concerns a model who has
a large investment in her wardrobe, but poses for a photographer
that ordinarily provides the wardrobe and strictly as a matter
of indulgence the photographer allows the model to use her own
clothes. Such an investment in clothes is not essential to the
services that she performs. "The photographer hires her only for
her photogenic qualities and her ability to pose; it is not required
that she furnish her own wardrobe."80
The critical test suggested by the IRS audit manual in deter-
mining if an investment is adequate is to compare the value of the
investment of the worker to the total value of all the facilities
needed to perform the work.
An investment in facilities is not adequate if the
worker must rely appreciably on the facilities of others
to perform the services. For instance, an individual
who is engaged to perform a machine operation on his own
premises and who furnishes his own equipment of sub-
stantial value may be a self-employed contractor instead
of an employee of the manufacturer.81
The realization-or-profit-or-loss factor is not only a major
part of the IRS audit guidelines, but it is also a factor included
in both the GAO proposal and H.R. 3245. In the GAO proposal,
"the risk of suffering a loss and opportunity of making a profit"
is one of the four basic tests used to determine if an independent
contractor engaged in a trade or business should be considered
self-employed.82 The only explanation of the factor provided by
the proposal is that there should be a "real possibility that
expenses directly related to the business will exceed business
On the other hand, H.R. 3245 provides considerable detail in
describing its third safe-harbor criteria which it calls "invest-
ment or income fluctuation."84 The bill proposes that a worker who
has a substantial investment or who risks income fluctuations should
satisfy this safe-harbor criteria.85 It treats investment and
income fluctuations as two separate components of an overall test
which can be satisfied by the presence of either a substantial
investment or risk of income fluctuation.
The income fluctuation test is satisfied if the income level
is neither fixed nor guaranteed, but rather directly depends on
the out-put of the worker. This can be exemplified by a salesman
who can make several sales presentations and not make a single sale.
This is not the same as an employee who is basically assured that
if he works a certain number of hours at a reasonably acceptable
level, he will receive a specified amount of compensation.8
Application of the substantial-investment-in-assets test is
similar to the income fluctuation test. The percent of the in-
vestment is not considered an important criterion despite the IRS
audit manual, but rather the worker must "invest a significant
amount of money or his time as in the income fluctuation test
with no assurance of success."87
with no assurance of success.
With the importance placed on the realization-of-profit-or-
loss factor by the IRS and the inclusion of the factor in both
the GAO proposal and H.R. 3245, it is not surprising that the
factor was discussed by judges in 119 of the 148 decisions included
in this study. In only twenty-nine decisions did the courts
fail to consider the realization-of-profit-or-loss factor in their
Before discussing the methods employed in the coding of the
variables, those factors that were deleted from the study due to
their infrequent occurrence in the written opinions will be pre-
sented. The following is a list of those seven factors discovered
in the literature review, but not included in the analysis of this
(1) Did the worker possess a special skill?
(2) Was the taxpayer's claim consistent with industry
(3) If required, who supplied special uniforms?
(4) What was the intent of the employer and worker?
(5) Did the worker receive any fringe benefits?
(6) Was the worker required to submit written or oral
(7) Can the worker terminate his relationship with the
employer at any time he wishes without incurring
Since none of these factors were included in more than 10 percent
of the court cases, this was interpreted as evidence that these
factors were not particularly relevant in determining what consti-
tutes a common law employee.
The only other factor that was discovered in the search for
relevant variables, but not used in this study was the "right to
discharge." Treasury Regulation Section 31.3121(d)-I(c)(2) mentions
the right to discharge as "an important factor indicating that the
person possessing that right is an employer." The IRS audit manual
discusses the right to discharge in the following manner--
The right to discharge is an important factor in indicating
that the person possessing the right is an employer. He
exercises control through the ever-present threat of dis-
missal, which causes the worker to obey his instructions.
An independent contractor, on the other hand, cannot be
fired so long as he produces a result which meets his
The IRS audit manual's definition, simply stated, is that an employee
can be fired anytime, but an independent contractor cannot be dis-
charged except under the terms of his contract. This rather sim-
plistic approach ignores the presence of union contracts that can
often limit the possibility of discharge of an employee. This
argument is supported by Marmoll as follows--
Since the law has developed in such a manner that most
employees have some protection against an arbitrary right
of discharge, and since many contractually agree with
their employers to give a certain amount of notice before
terminating the employment relationship, the restate-
ment's explanation of who is a "servant" or "employee"
does not mention the right to discharge. Moreover,
there are courts which, while considering the factor
of right to discharge or right to terminate, have placed
the factor in perspective, not allowing it to govern
the case despite the exaggerated importance given to the
factor in the regulations.89
One District Court has held that simply because the taxpayer
had the right to discharge the worker if his services were not
satisfactory in "no way" meant that an employer-employee relation-
This same right exists in every contractor who had
employed a subcontractor when the latter's performance
falls below standard. An applicator who did not like a
particular assignment was free to refuse it and in such
a case the plaintiff would attempt to give him another
This same position is taken again by another District Court in a
While it is true that he could terminate an applicator's
work before the completion of a particular job if the
desired result was not being accomplished, this power
was no different than that of a general contractor to
declare a breach of his contract had been committed by
What makes this factor even more difficult to understand in
this type of study is that the written opinions of the judges
ordinarily fail to provide enough information to adequately
determine if this so-called right-to-discharge factor is really
being applied to an independent contractor relationship or an
employer-employee relationship. Because of the inability to
ascertain when the right-to-discharge factor was present in the
written opinions, it was decided to delete this factor from the
With the selection of the eleven factors completed, the
mathematical models necessary to answer Research Question 2 can
be constructed. Before developing the methodology to be used in
studying Research Question 2, it is first necessary to discuss the
coding procedures used in the analysis of the data.
Coding of the Variables
Each of the eleven variables previously defined was treated
as a trichotomous random variable when collecting the data from
the court cases. There are alternate methods of coding tricho-
tomous independent variables in building mathematical models.
To obtain the maximum amount of information contained in this
type of data, each variable should be represented by two dummy
variables. For example, factor 8, method of payment, would be
coded as follows: (1) if the worker was paid by the job, variable
XI would be coded as a 1 and 0 otherwise; (2) if the worker was
paid by the hour, variable X2 would be coded as a I and 0 other-
wise; and (3) if the method-of-payment factor was not mentioned
by the court, then both XI and X2 would be equal to zero.
This simple model could be expressed as
Y = B + BIXI + B22 + U, (3.1)
Y is the probability of a worker being classified
as an employee,
U is the error term,
B's are the independent variable coefficients.
Taking the expected values of this model results in
E(Y1IXI = 0, X2 = 0) = B0 + BI
E(Y IXI = 0, X2 = 1) = B + B2
E(YIIXI = 0, X2 = 0) = B .
The interpretation of these coefficients would be that B0 equals
the "probability of an employee finding" (hereafter referred to
as Y) if the method-of-payment factor was not mentioned in the
case. If BI is added to BO, this represents Y when a worker is
paid by the job while B0 + B2 equals Y if the work is paid by the
hour. The difference in Y according to whether a worker is paid
by the hour or by the job is
B + BI (B + B2 = BI B2.
A different approach using a trichotomous independent variable
in building a mathematical model would be to simply represent
the method-of-payment factor with three values. For example,
0 could represent the worker being paid by the job, I could re-
present the method-of-payment factor not being mentioned, and 2
could represent a worker being paid by the hour. This simple model
could be represented as
Y = B0 + BIXI + U. (3.2)
Taking the expected value would give
E(YIXI = 0) = BO,
E(YIXI = 1) = B0 + BI,
E(YIX1 = 2) = B0 + 2B2.
At first glance the only difference in the expected values for
model 3.2 and those calculated for model 3.1 would be the expected
values of Y given the worker is being paid by the hour. However,
a more important difference is that the expected values for model
3.2 imply that the difference in Y when the method-of-payment factor
is not mentioned and when the worker is paid by the job is
(B0 + BI) B0 = BI
while the difference in Y when the method-of-payment factor is not