Please note, the following summarizes our understanding of California and Federal Law, but it is not legal advice. Consult your accountant and/or attorney before making any decisions.

Many hourly employees hear that if they work as an independent contractor, they can make more money. They will be able to deduct expenses, and pay fewer taxes. This may or may not be the case, depending on individual situations. Independent contractors must file quarterly returns, and pay a 15% self-employment tax on estimated earnings. If you think you are really an independent contractor, and there would be financial benefits for you (given significant business expenses like a home office and computer system, frequent client visits, high-speed internet connection, etc. that would offset your taxes) you may want to make the change. In that case, there are very strict IRS and California regulations to define what tests an individual must meet to work as an independent contractor.

Especially in California, the Employment Development Department (EDD) screens returns of independent contractors who file IRS Tax Form 1099, rather than the employee form W2. (Independent contractors often call themselves "1099's.") Unless you are incorporated (in which case you become an employee of your own corporation, keep your own books, and pay your own employer and employee taxes), you are likely to be audited.

If the EDD believes that you do not meet the test for filing a 1099, you, your agency, and the client you worked for will all be assessed employment tax, interest, and penalties. These are significant, and there is no recourse.

So, to avoid this, if you want to work as an independent consultant, you should be able to meet the IRS definition of an independent contractor:

By IRS definition, you are an employee if the person for whom you work has the right to direct and control the way you work. This means they control both the result and the details of when, where, how, and in what sequence you work. It is the IRS' view that the employer need not actually exercise control. It is sufficient that it has the right to do so. Financial responsibility for error is also key. Typically, independent contractors provide fixed-price bids for a specific job, and do not bill hourly.

For example, a roofing contractor is an independent contractor. He (or she) is an expert at roofing. They come, they look at your roof, and they give you a written estimate. They are responsible to complete the work as per their written estimate. They may specify timing, but they are unlikely to tell you just how they are going to spread the tar or nail the shingles, and you don't get to direct their work. At the end, you pay the amount agreed to, and the risk is theirs as to whether they bid correctly or not.

Because there are many grey areas, the IRS has adopted 20 criteria to determine if you are an employee or an independent contractor. These are summarized as 20 questions, which follow. For California law, questions 1, 2, 4, 5, 7, 9 and 16 seem to be most critical). We have included the answer a true independent contractor would give in parenthesis after each question:

1. Are you required to comply with instructions about when, where, and how the work is to be done? (No.)
2. Does your client provide you with training to enable you to perform a job in a particular method or manner? (No.)
3. Are the services you provide integrated into your client's business operation? (No.)
4. Must the services be rendered by you personally? (No.)
5. Do you have the capability to hire, supervise, or pay assistants to help you in performing the services under contract? (Yes.)
6. Is the relationship between you and the person or company you perform services for a continuing relationship? (No.)
7. Who sets the hours of work? (You do.)
8. Are you required to devote your full time to the person or company for which you perform services? (No.)
9. Do you perform the work at the place of business of the potential employer? (No.)
10. Who directs the order or sequence in which you work? (You do.)
11. Are you required to provide regular written or oral reports to your client? (No.)
12. What is the method of payment - hourly, commission or by the job? (Fixed price, not-to-exceed, and/or milestone payments are standard for independent contractors.)
13. Does the client reimburse your business and/or traveling expenses? (No.)
14. Who furnishes tools and materials used in providing services? (You do. This includes workstation, Internet, etc.)
15. Do you have a significant investment in facilities used to perform services? (Yes. Key here is "significant." Lots of employees have a home computer.)
16. Can you realize both a profit and a loss from your work? (Yes-very important-you must assume risk based on client satisfaction with your work.)
17. Can you work for a number of firms at the same time? (Yes.)
18. Do you make your services available to the general public? (Yes. You should have business cards, stationery, invoices, and a business listing in the phone book, for example.)
19. Are you subject to dismissal for reasons other than nonperformance of contract specifications? (No.)
20. Can you terminate your relationship without incurring a liability for failure to complete a job? (No. If you work on a project or milestone, basis, you must deliver to receive payment for your efforts.)

In summary, true independent contractors usually have years of experience, multiple clients for whom they work, a substantial home office, and a contract between themselves and the client that enforces the appropriate expectations of the 20 questions.