What’s the ABC Test for Independent Contractors?
The line between independent contractor and employee is often blurred. Between the confusing state laws and the ever-changing IRS definitions, it can be a real puzzle to figure out what you should be classified as!
A realtor, for example, is a licensed agent who provides assistance with all matters pertaining to real estate according to the regulations of the specific state or country.
They often perform “freelance” work, i.e. are self-employed. However, they also may work under a broker within an agency. Are they then considered an employee of that agency? It can be hard to tell.
If you find yourself in this type of work field, it is important for your business and your wallet to understand the tax implications, benefit expectations, and the ABC Test for independent contractors.
The ABC Test Components
Determining if you are a contractor might sound simple, but is it really?
When a realtor is not necessarily defined by a real estate firm as an employee and continues to provide services by working closely with employees from an entity for an unspecified period of time, that is when the blurred lines start to emerge.
You may be asking: Do I still consider myself self-employed or should I be included within the payroll of the entity?
Let’s help you decipher the unwritten code!
The ABC Test for independent contractors is one way of determining if a person is an employee or freelancer for a business. It’s not a mandatory test but rather a method used by the Department of Labor and many states to determine an employee classification.
The test has three components: absence of control by employer, primary business of the worker, and if the worker is customarily engaged.
If a worker’s situation meets all three components, they should be classified as an independent contractor!
First Component: Absence of Control
The first component of the ABC Test is absence of control. This means that you as the worker are not directly controlled by your “employer” or hiring company when it comes to performing your work. It’s considered the most important component of this test.
As the employer, the company that hires you has some amount of control over the work you produce regardless if you are an employee or independent contractor. They can dictate what the work is, when it is due, and the details included in the work.
But beyond the scope of work, an employer can’t control the working habits of independent contractors.
If any of these sound like what you are doing for a company, it may be appropriate to be classified as an employee rather than self-employed:
Your employer sets your schedule and hours
Your employer dictates what your work entails
Your employer sets your dress code
Second Component: Business of the Worker
The second component of the ABC Test for independent contractors is the business of the worker. To be considered a freelance worker, your work should be “unusual” or comparatively different from the hiring company’s main work.
Consider our real estate agent example.
The argument could be made that an agent employed to sell houses by a broker whose primary business is selling houses should be considered an employee under this component of the ABC Test. Both the employee and employer are conducting similar business.
When a client hires a real estate agent to help them sell a home, though, that client is not considered an employer. That client will most likely have a totally different job or business unrelated to the agent’s work, thus meeting the second component to classify the agent as an independent contractor.
Third Component: Customarily Engaged
The third component of the ABC Test for independent contractors is if the contractor is customarily engaged. This is a fancy phrase for a person being hired on a per-job basis.
As a real estate agent, you are typically working house-by-house. You are separately engaged to help sell or purchase one home at a time for a client or broker.
A further tier to this component is that independent contractors are running their own business. Their business has a separate identity from their employer’s business.
If you as a real estate agent have your own business outside your broker’s business, you are probably an independent contractor. If you only conduct business under your broker’s company and are primarily dependent on that company for income, you may be an employee.
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What else should you consider?
As a self-employed realtor, you must be aware that you are forgoing common rights or perks that you would otherwise possess as an employee.
Some of the drawbacks when performing freelance work often include lack of paid time off, sick days, 401K matches, medical/dental/vision benefits, and employer’s paid portion of payroll tax, social security, and medicare.
BUT…if all of the above perks are not immediate needs and you enjoy the pace of your own work then being self-employed can be extremely rewarding!
Final Thoughts
As a contractor, you can expect the entity to classify you as “independent” and report you on a 1099-NEC Form at year end. This form specifies the amount paid to you throughout the year. You will not be entitled to receive a W-2 for a regular employee who receives a constant wage or salary for routine work.
And most importantly - you are on the hook for filing your own taxes! Check out our article on Employee vs. Contractor Taxes here.
