Contract City Attorneys: The Employee vs. Independent Contractor Conundrum
Devala A. Janardan
International Municipal Lawyers Association
Web-posted March 2007
This article appears in the March/April 2007 issue of the Municipal Lawyer, published by the International Municipal Lawyers
Association (IMLA), 7910 Woodmont Ave., Bethesda, MD. 20814, and is reproduced with the permission of IMLA. IMLA is a non-
profit, professional organization that has been an advocate and resource for local government attorneys since 1935. IMLA serves
more than 1,400 member municipalities and local government entities in the United States and Canada, and is the only international
organization devoted exclusively to addressing the needs of local government lawyers. Further information about IMLA is available
at IMLA’s website, www.imla.org.
The City of Henderson (City) is a small municipality in the heart of Texas. With a population of
13,000, it is large enough to need the services of an attorney, but not large enough to keep one as
part of its permanent staff. Henderson does what a large number of similarly-sized municipalities
do: instead of hiring an attorney as a permanent employee, it hires outside attorneys as
independent contractors to provide services to the City on a retainer basis. Over the past year, the
City and its attorney, Mr. David P. Brown, have been part of an all too common struggle with the
Internal Revenue Service (IRS) to reclassify Mr. Brown as a Henderson City employee, rather
than an independent contractor. The IRS based their attempt to reclassify Mr. Brown on a
showing that he received a retainer fee plus evidence that he contracted with the City to receive
health insurance, life insurance, and access to exercise facilities – benefits traditionally reserved
for city employees. The City contended that Mr. Brown was an independent contractor because
the City did not have any control over the methods and means by which Mr. Brown did his work,
nor did it provide him with workplace or the services of support staff. In addition, Mr. Brown
was not entitled to receive vacation or sick pay, and his method of payment was different than
for city employees (retainer basis vs. bi-weekly salary). In response to evidence showing that he
received certain benefits traditionally reserved for city employees, Mr. Brown stated that this
was simply the result of the negotiation process with the City: a reduced retainer fee in return for
selected services provided by the City.
The distinction between employee and independent contract is a very fine one indeed. Since
countless municipalities across the nation employ outside counsel as independent contractors,
this column will provide some guidelines for municipalities utilizing such outside assistance.1
At the most basic level, an employer must withhold federal income tax2 and pay Federal
Insurance Contributions Act (FICA)3 taxes (which include social security and Medicare
payments) if a worker is classified as an employee. In making this determination, the primary
legal focus is whether the “person for whom services are performed has the right to control and
direct the individual who performs the services.”4 The IRS uses a fact-specific determination
under common law to determine a worker’s status. In Revenue Ruling 87-14, the IRS sets out a
list of 20 factors (commonly referred to as the “Twenty Factor Test”) to be used as an analytical
tool in clarifying the relationship and determining how a worker should be classified.5 Although
the IRS has kept the Twenty Factor test, it has supplemented the test and now also relies on
evidence of “degree of control and independence” as categorized in three ways: behavioral
control, financial control, and evidence showing the “type of relationship.”6
Under the category of behavioral control, the IRS looks at factors such as the instructions that are
given to the worker by the hiring entity, as well as any training provided to the worker, and
evidence of whether the recipient of the worker’s services has a right to direct or control how the
worker performs the tasks for which he or she is hired.7 In the financial control category, the
focus is on the independence of the work and includes factors such as: (1) whether the hiring
entity reimburses the worker for business expenses, (2) the extent of the worker’s investment, (3)
how the worker makes his or her services available to the general marketplace, (4) how the
hiring entity pays the worker, and (5) the profit potential or risk of loss placed on the worker.8
The final category, the type of relationship between a worker and a hiring entity, includes
evidence of written contracts, whether or not the entity provides the worker with employee-type
benefits (such as health insurance, vacation pay, or fringe benefits), the length and permanency
of the relationship, and how integrated a worker is in respect of the key aspects of the entity.
A hiring entity can also be afforded relief from federal tax obligations through safe haven
authorizations set by Congress in Section 530 of the Revenue Act of 1978.9 The IRS Internal
Revenue Manual,10 which sets out mandatory procedures for IRS examiners, states that “Section
530 is a relief provision that should be considered as the first step in any case involving worker
classification … [r]elief is available to businesses that are under examination … with respect to
assessments based on employment status reclassification.” Section 530 relief is based on three
requirements: (1) a reasonable basis for not treating workers as employees; (2) substantive
consistency; and (3) reporting consistency. Under Section 530(a)(2), reasonable basis can be
established by reasonably relying on judicial precedent, published rulings, or letter ruling to the
taxpayer. Reasonable basis can also be established if there is “a long-standing recognized
practice of a segment of the industry in which the individual [is] engaged.”11 Substantive
consistency requires that the hiring entity “must have treated the workers, and any similar
workers, [all] as independent contractors.”12 The final requirement for employment tax relief is
for the hiring entity to have consistently filed a form 1099-MISC for each worker.13
The IRS, realizing the complexity of the employee / independent contractor distinction, provides
assistance in determining worker status so that surprises don’t occur during IRS audits and other
events. Form SS-8, aptly titled “Determination of Worker Status for Purposes of Federal
Employment Taxes and Income Tax Withholding,” may be submitted to the IRS to clarify
worker status.14 This form does not apply to “proposed transactions or hypothetical situations,”
but an information letter may be issued by the IRS if it deems it necessary.15
The IRS has reportedly ramped up efforts to accurately classify worker status over the past few
years.16 The determination of whether a worker is an independent contractor or employee is
indeed a complicated one, requiring careful planning by both the hiring municipality and the
worker; however, careful planning in advance may prevent major financial and administrative
burdens in the future.
1. This article does not address FICA responsibility in relation to “Section 218” agreements. For
more information, see http://www.ssa.gov/slge/sect_218_agree.htm.
2. 26 U.S.C.A . § 3401(c) (2005). See also http://www.irs.gov/pub/irs-pdf/p15a.pdf.
3. 26 U.S.C.A. § 3121(d) (2005).
4. 26 C.F.R. § 31.3121(d)-1 (1987).
6. See, e.g., IRS Publication 15-A (2007) at http://www.irs.gov/pub/irs-pdf/p15a.pdf.
7. IRS Publication 15-A - Employer’s Supplemental Tax Guide, (2007). Specifically, the
instructions include when and where to do the work, what tools or equipment to use, what
workers to hire or to assist with work, where to purchase supplies, what work must be performed
by a specific individual, what order or sequence to follow.
9. See Section 530 of P.L. 96-600, 92 Stat. 2885 (1978) as amended by P.L. 96-167, 93 Stat.
1278 (1979); P.L. 96-541, 95 Stat. 3204 (1980); P.L. 97-248, 96 Stat. 552 (1982); and P.L. 104-
188, 110 Stat. 1766 (1996).
10. IRS Manual, § 4.23.5 (Feb. 2003), at http://www.irs.gov/irm/part4/ch23s05.html.
12. IRS Publication 1976 (Sept. 1996) at http://www.irs.gov/pub/irs-pdf/p1976.pdf.
14. IRS Form SS-8 - Determination of Worker Status for Purposes of Federal Employment
Taxes and Income Tax Withholding (2006) at http://www.irs.gov/pub/irs-pdf/fss8.pdf.
16. Sandra Block, No More Mr. Nice Guy - IRS Swoops in for Audits, USA TODAY (April 13,
2005) at http://www.usatoday.com/money/perfi/taxes/2005-04-13-irs-gets-tough_x.htm.