Why the 20-factor test still matters
When a US company asks whether a worker is a contractor or an employee for federal tax purposes, the starting point is the common-law test the Internal Revenue Service has applied for decades. The most widely cited reference is Revenue Ruling 87-41, 1987-1 C.B. 296, which lists twenty factors that bear on whether a worker is an employee under the common law. The IRS published this ruling in 1987 and has not revoked it. Modern IRS guidance still relies on the underlying analysis even though the agency now presents the same factors grouped into three categories.
The ruling itself is available as a primary source through the Michigan Workers’ Compensation Agency archive at michigan.gov: IRS Rev. Rul. 87-41. The IRS public-facing summary appears at irs.gov: Independent contractor or employee.
This article walks through the twenty factors, explains the three-category grouping that the IRS now uses, and points to the patterns that practitioners see in audits.
A short history of the test
The common-law test long predates Rev. Rul. 87-41. It was inherited from English master-and-servant doctrine and refined through US tax cases for most of the twentieth century. By the mid-1980s, the IRS had accumulated enough rulings and case law that it consolidated the analysis into a single guidance document. That document is Rev. Rul. 87-41, published in 1987.
The ruling does not invent a new test. It compiles the factors that courts and the IRS had been weighing for years. Its value is that it places the factors in one place. Its limitation is that it leaves the weighing of the factors to the facts of the case. As the ruling itself says, the degree of importance of each factor varies depending on the occupation and the factual context.
The IRS now also publishes a simpler taxonomy on its website, grouping the twenty factors into three categories: behavioral control, financial control, and type of relationship. That grouping comes from the IRS Topic No. 762 guidance at irs.gov: Topic no. 762 and from training materials the IRS issues to its examiners. The grouping is a presentation device. The substantive analysis is still the twenty-factor common-law test.
The three categories
Before walking through the twenty factors one by one, it helps to anchor them in the three categories the IRS uses today.
Behavioral control
Behavioral control asks whether the business has the right to direct and control how the work is done. The IRS website at irs.gov: Topic no. 762 says behavioral control covers facts that show whether the business has a right to direct and control what the worker does and how the worker does the job, through instructions, training, or other means.
Financial control
Financial control asks whether the business controls the business aspects of the worker’s job. This covers method of payment, who supplies tools, whether the worker can realise a profit or loss, the level of investment the worker has in their own enterprise, and whether the worker has unreimbursed business expenses.
Type of relationship
Type of relationship asks how the parties characterise their relationship in practice. This covers written contracts, whether the business provides employee-type benefits, the permanence of the engagement, and whether the work performed is a key aspect of the business.
The twenty factors
The twenty factors come directly from Rev. Rul. 87-41. The numbering and labelling below follow the ruling. Each factor is paired with the category it most naturally falls under.
1. Instructions (behavioral)
A worker who must comply with another person’s instructions about when, where, and how to work is ordinarily an employee. The relevant question is whether the business has the right to instruct, not whether it actually does so.
2. Training (behavioral)
Training a worker by requiring an experienced employee to work with them, by requiring attendance at meetings, or by using other methods, indicates that the business wants the services performed in a particular way. Contractors typically use methods they choose themselves.
3. Integration (relationship)
Integration of the worker’s services into the business operations generally shows that the worker is subject to direction and control. If the business depends on the worker for its core service, this points to employee status.
4. Services rendered personally (relationship)
If the services must be performed personally by the worker, that points to employer interest in the methods used and to employee status. A contractor would typically have the right to send a substitute.
5. Hiring, supervising, and paying assistants (financial)
If the business hires, supervises, and pays assistants for the worker, that suggests an employer-employee relationship. A contractor would normally hire and pay their own assistants.
6. Continuing relationship (relationship)
A continuing relationship between the worker and the business indicates an employer-employee relationship. The ruling notes a continuing relationship may exist where work is performed at frequently recurring although irregular intervals.
7. Set hours of work (behavioral)
The establishment of set hours by the business is a factor indicating control. Contractors typically set their own hours.
8. Full time required (relationship)
If the worker must devote substantially full time to the business, that restricts the worker from doing other gainful work and indicates control. A contractor is generally free to work when and for whom they choose.
9. Doing work on the employer’s premises (behavioral)
If the work is performed on the business’s premises, that suggests control, especially where the work could be done elsewhere. This factor is weakened today by remote work realities and the IRS reads it in light of whether the location reflects a control choice or a practical necessity.
10. Order or sequence set (behavioral)
If a worker must perform services in the order or sequence set by the business, that shows the worker is not free to follow their own pattern of work. The IRS treats this as a strong indicator of control.
11. Oral or written reports (behavioral)
A requirement that the worker submit regular reports indicates a degree of control consistent with employee status. Periodic project updates from a contractor do not by themselves rise to this level.
12. Payment by hour, week, or month (financial)
Payment by the hour, week, or month generally points to an employer-employee relationship. Payment by the job, or on a straight commission, generally indicates a contractor. The ruling cautions that the payment method must reflect substance, not just labelling.
13. Payment of business or travelling expenses (financial)
If the business pays the worker’s business or travelling expenses, that ordinarily indicates an employer-employee relationship. Contractors generally absorb these costs and price them into their fees.
14. Furnishing of tools and materials (financial)
If the business furnishes significant tools, materials, and other equipment, that suggests an employer-employee relationship. Contractors typically supply their own.
15. Significant investment (financial)
If the worker invests in facilities used for the work, particularly facilities not typically maintained by employees, that tends to indicate independent contractor status. Significant investment shifts financial risk to the worker.
16. Realization of profit or loss (financial)
A worker who can realise a profit or suffer a loss as a result of their services is generally a contractor. An employee is paid regardless of the outcome of the project.
17. Working for more than one firm at a time (relationship)
If a worker performs more than de minimis services for multiple unrelated firms at the same time, that generally indicates contractor status. Exclusive work for a single business often points to employment.
18. Making services available to the general public (relationship)
A worker who makes their services available to the public on a regular and consistent basis is generally a contractor. Marketing, advertising, business cards, and a listing in the trade press all support this factor.
19. Right to discharge (relationship)
The right to discharge is an important factor in indicating that the person possessing the right is an employer. A contractor is not subject to discharge as long as the contract terms are met.
20. Right to terminate (relationship)
If a worker has the right to end the relationship at any time without incurring liability, that indicates an employer-employee relationship. A contractor who walked off a project mid-engagement would generally be in breach.
How the IRS weighs the factors
The common pitfall is to count factors. A company will look at the twenty-factor list, conclude that nine factors point to contractor status and eleven point to employee status, and assume the nine wins. That is not how the analysis works.
Rev. Rul. 87-41 is explicit: the degree of importance of each factor varies depending on the occupation and the facts and no single factor is decisive. The IRS examines the totality of the relationship. In some occupations, behavioral control factors weigh heavily because direction of work is the central economic question. In professional service relationships, financial control factors often dominate because the work itself can be done many different ways. In long-term engagements, relationship factors come to the fore because the duration and exclusivity of the work tell the real story.
In practice, IRS examiners look first at the strongest indicators on each side. If the worker has been paid weekly for two years, has no other clients, follows the company’s processes, attends company meetings, and works at the company’s site, no amount of contract language calling them a contractor will save the classification. Conversely, a vendor who runs their own agency, has multiple clients, sends invoices for completed deliverables, and uses their own tools is not made an employee by the fact that the company asked them to be on a recurring Friday call.
The common pitfalls
Three patterns appear repeatedly in misclassification audits.
The first is scope creep. A worker is engaged for a defined project and stays on for years, drifting into general support work. The relationship factors slowly tip toward employment as integration and continuity build up. The original contract is no longer descriptive of the actual relationship.
The second is uniform process compliance. The company has employees and contractors using the same tools, the same workflows, the same meeting cadences, and the same internal systems. Behavioral control factors begin to converge for both groups. The contractor designation becomes a label rather than a substantive distinction.
The third is single-client dependence. The contractor has only one client. They invoice that one client regularly. They have no public profile as a service provider. They could not, in practice, walk away tomorrow and pick up the same work elsewhere. The relationship factors and the economic reality both lean toward employment.
The IRS, the Department of Labor, and state agencies all look for these patterns. None of them is fatal on its own, but combinations are.
Section 530 relief and the common law
A US company that has misclassified a worker may still be eligible for relief under Section 530 of the Revenue Act of 1978 if it meets three statutory requirements: reporting consistency, substantive consistency, and reasonable basis. The IRS describes Section 530 at irs.gov: Section 530 relief. Section 530 does not change the common-law analysis. It is a separate safe harbor that, where it applies, terminates employment tax liability for the misclassified workers. It is the topic of a separate article in this series.
What this means for a US founder or HR lead
The practical work is to write down what the company actually does with each contractor and compare it to the twenty factors. Most companies that find themselves in difficulty did not deliberately misclassify anyone. They engaged a contractor under a contract that fit the facts at the time, then let the relationship drift over a year or two until the contractor was indistinguishable from an employee.
A simple internal review takes an afternoon. List each contractor. For each, note who controls the schedule, who provides tools, who pays the expenses, whether the contractor has other clients, how the relationship can be terminated, and how long it has been going on. Compare the answers to the twenty factors. If the answers cluster on the employee side, the classification needs to be revisited.
Contract management software can help by enforcing a consistent contractor agreement and a recurring review cadence. Omnivoo’s contract management workflow keeps the contract terms, invoices, scope-of-work, and renewal status in one place so the relationship can be reviewed against the common-law factors when it matters, which is before an audit notice arrives.
Sources
- IRS, Revenue Ruling 87-41, 1987-1 C.B. 296: michigan.gov: IRS Rev. Rul. 87-41
- IRS, Independent contractor (self-employed) or employee: irs.gov: Independent contractor or employee
- IRS, Topic No. 762, Independent contractor vs. employee: irs.gov: Topic no. 762
- IRS, Section 530 relief for worker reclassification: irs.gov: Section 530 relief