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Employee/independent contractor determinations.

Employee/Independent Contractor Determinations

Among the areas receiving increased scrutiny recently from the Internal Revenue Service is employee/independent contractor determinations. The IRS estimates an annual $1.5 billion loss of revenues because of misclassification of workers as independent contractors rather than employees. Organizations found to be in violation of the FICA withhold payment requirements could be subject to significant penalties and assessments.

The determination of whether an individual is an employee or an independent contractor must be based on all the facts and circumstances of a particular case. It is essentially a matter of which way a preponderance of facts point. Moreover, the IRS views the contracting organization as having the burden of proof to show independent contractor status. A person is not an independent contractor merely because he or she is called one or because he or she has entered into an agreement that states that the parties are independent contractors.

The overriding factor in the determination is the degree of control the contracting organization has over the individual's activities. However, cases and rulings in this area also show that the employment status of professionals such as physicians, dentists, and lawyers must be analyzed with appropriate recognition of the professional standards applicable to such persons. While the traditional view has been that it may be easier in many situations to establish an independent contractor relationship with a physician than, for example, with a clerical worker, recent IRS letter rulings bring this assumption into question.


Guidance for determining a worker's status is found in Sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1 of the Employment Tax Regulations, which relate to the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and federal income tax withholding, respectively. Section 31.3121(d)-1(c)(2) of the regulations provides that, generally, the relationship of employer and employee exists when the person for whom the services are performed has a right to control and direct the individual who performs the services, not only as to results to be accomplished by the work but also as to the means by which the work is accomplished.

Thus, an employee is subject to the will and control of the employer, not only as to what shall be done but also as to how it shall be done. In this connection, however, Section 31.3401(c)-1(b) of the regulations provides that it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if it has the right to do so. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished and not as to the means, he or she is an independent contractor. The regulations conclude by stating: "Individuals such as physicians, lawyers, veterinarians...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 employees."

The IRS has also employed a 20-factor test to be used in determining whether a worker is an employee or an independent contractor (see Rev. Rul. 87-41, 1987-1 C.B. 296).

However, the IRS has recognized that these 20 factors are only guidelines in determining whether there is sufficient control and direction over the worker. In many cases, certain of these factors are irrelevant to that determination.

In an early ruling (Rev. Rul. 84, 1953-1 C.B. 405), the IRS stated that a physician engaged in the private practice of medicine who performed part-time medical services for a corporation was an independent contractor, notwithstanding the fact that he or she had fixed hours at the corporation.

In Rev. Rul. 66-274, 1966-2 C.B. 446, the IRS held that a physician who contracted to head the department of pathology at a hospital was an independent contractor. In that ruling, the agreement between the physician and the hospital provided that the hospital would furnish the necessary space, equipment, facilities, and personnel required for the operation of the pathology department so that the physician had to make very little, if any, capital investment in the department. Nonprofessionals in the department were employees of the hospital although subject to the physician's approval. While the physician had no specified hours, he was obligated to be in attendance at the hospital for a minimum of one-half of his working time. While the physician was not subject to supervision in the performance of his services, he was required to keep proper records and to write periodic reports concerning services rendered to the department. The rates for the physician's services were jointly set by the physician and the hospital administrator. The physician had the right to have a qualified pathologist to assist him in his duties, but his choice was subject to the hospital's approval.

In Rev. Rul. 66-274, the IRS relied heavily on the rationale of Rev. Rul. 61-178, 1961-2 C.B. 53, which stated that physicians who are engaged in the pursuit of an independent medical practice in which they offer their services to the pubic are generally considered independent contractors unless subject to direct control and supervision. The ruling stated that whether the requisite control and supervision exists is determined by several criteria, including:

1. The degree of integration into the operating organization of the contracting firm.

2. The substantial nature, regularity, and continuity of his or her work for such firm.

3. The authority vested in or reserved by such firm to require compliance under its general policies.

4. The degree to which the individual under consideration has been accorded the rights and privileges that such person or firm has created or established for its employees generally.

Rev. Rul. 66-274 also states that it is difficult to assign particular weights to the various factors, and each case must be determined on its own facts because these factors are only relevant in indicating control and direction of a service provider's work. In determining whether services are integrated, the ruling indicated that the IRS will consider, among other factors, whether there are restrictions on the individual's ability to perform services for others and the presence of employee benefits. As to the authority factor, the ruling looks at whether the physician is subject to direction and control by a chief of staff, a medical director, or some other authority. The pathologist in this case was determined to be an independent contractor because, among other reasons, he had the right to perform services for others, was not required to adhere to general rules applicable to hospital employees, and was not entitled to usual employee benefits.

In Rev. Rul 57-380, 1957-2 C.B. 634, an anesthetist entered into an agreement with two hospitals to provide anesthesia services. The agreement with the first hospital provided that the anesthetist would set his own fees, which would be collected by the hospital and be paid to the anesthetist. However, the agreement with the second hospital provided that the anesthetist would receive a fixed monthly amount and the hospital would furnish all of the necessary anesthesia equipment and supplies. Neither hospital issued instructions or directions to the anesthetist in connection with his services, other than to inform him of the time for which operations were scheduled. The anesthetist received no employee benefits from either hospital and maintained his own private practice. The ruling held that the anesthetist was an independent contractor because neither hospital exercised or had the right to exercise the control necessary to establish an employer-employee relationship.

In contrast to the line of Revenue Rulings discussed above, in a recent set of Private Letter Rulings (PLRs), the IRS has taken a more conservative position regarding professionals (see PLRs 9041030-034, Oct. 12, 1990). While PLRs are specific to the cases discussed and do not have general binding authority, they are an indication of current IRS thinking. PLRs 9041030-034 all deal with individuals working for a firm in the business of providing psychiatric and psychological services to the public.

In PLR-9041031, the professional in question was a licensed psychiatrist who provided psychiatric services to patients of the firm. The psychiatrist stated that he receive no training or instruction from the firm, that the firm had no right to direct him in the performance of his services, and that he provided services to the firm only 6-8 hours per month. Furthermore, he received no fringe benefits from the firm and was not restricted from competing with the firm.

Despite all of the above factors, the IRS determined that the psychiatrist was an employee of the firm. The IRS seemed to rely in large part in this finding on the notion that the psychiatrist's services were an "integral part" of the firm's business. In so doing, with questionable reasoning and in a seeming departure from past IRS views, the IRS largely ignored the control issue.

The IRS reasoned as follows:

"Careful consideration has been given to the information submitted in this case and while it appears that the firm exercises little direction and control over the worker in the performance of his services, when the success of continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business. Further, as stated above, because of the manner in which professional men and women perform their services, it is often difficult and in some situations either impossible or unnecessary for an employer to exercise direction and control over such workers in the performance of their services. Therefore, in work relationships involving professional men and women, the factors of direction and control are given less weight in determining the employer-employee relationship and, under the circumstances described in this case, are held to be nondeterminative.

"In acquiring the services of professionals in other specialized fields related to its business, it is clear that the firm's goal is to provide its patients with a total care concept of interrelated services involving other specialized disciplines and occupations. As a skilled professional providing services in such an environment, it is unlikely that the worker is engaged in the independent practice of his profession. However, the fact that the worker performs his services under such circumstances does indicate that he is an integral part of the firm's business and that his services comprise an essential part of that total care concept envisioned by the firm for the benefit of its patients. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control."

In reaching its conclusion, the IRS also pointed to the fact that the firm provided secretarial and billing services to the psychiatrist, that the relationship was terminable-at-will, and that the psychiatrist was paid in a manner (a percentage of the amount billed by the firm for the psychiatric services rendered) that meant he could not suffer a loss or realize a profit from his services to the firm.


As can be seen from the foregoing examples, an independent contractor relationship can be found even where indicia of employment are present. On the other hand, an employee relationship may be found where indicia of independent contractor status are present. Any final determination would be based on analysis of all of the facts and circumstances in a particular case. Of course, the IRS' view on issues of this nature is generally inclined to finding employer-employee relationships. While a court would not necessarily uphold the IRS' view, health care organizations need to pay close attention to developments in this area in order to minimize exposure to potentially significant negative tax consequences.

Douglas A. Hastings, Esq., is a partner with Epstein Becker & Green, P.C., Washington, D.C. He also serves as editor for this regular column of Physician Executive.
COPYRIGHT 1991 American College of Physician Executives
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Author:Hastings, Douglas A.
Publication:Physician Executive
Date:Mar 1, 1991
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