For years, employers have struggled with correctly classifying workers as employees or independent contractors.
When the economy went south, the problem became more serious as various state and federal agencies, seeking revenue, brought enforcement actions against companies that misclassified workers. Employees filed suit as well, typically under the Fair Labor Standards Act.
At the same time, employers seeking to improve cash flow may have opted for a more generous interpretation of what constitutes an independent contractor.
To help steer businesses toward compliance, agencies like the Department of Labor and the Internal Revenue Service created tests to determine whether or not an employee qualifies as an independent contractor.
The two agencies also established the Federal Misclassification Initiative, which launched the hiring and training of additional government investigators to identify companies that misclassify workers.
As part of the initiative, the agencies agreed to work together and share information about businesses that are misclassifying employees.
Employers seeking to achieve compliance can look to the tests to ensure workers are correctly classified – or face some serious consequences.
The cost of misclassification can add up quickly.
Penalties may be owed to both the IRS and the DOL and a worker – individually or as part of a collective action – can recover back pay and liquidated damages under the FLSA as well as attorney’s fees.
In addition, failure to provide workers’ compensation could result in increased insurance premiums or a potential tort suit if the individual is injured.
“Employers need to evaluate with a keen eye the positions they are filling,” said Kevin B. McCoy, a Tysons Corner attorney.
Forethought and planning can go a long way towards eliminating the potential problems for an employer, he added, with the creation of detailed job descriptions.
“If the company sits down and writes up the four or five core duties of the position, with another five to eight tasks also performed, then they can look at the list and say: is this an employment position or an independent contractor position?”
Control is the touchstone
Why the popularity of classifying a worker as an independent contractor? It cuts down on the administrative burden and cost for employers, who do not have to withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee.
But if the worker is misclassified, those savings on the front end could cost employers on the back end, with the potential for fines and lawsuits.
For employees, working as an independent contractor also presents benefits, like the freedom to leave the job on a whim and greater control over day-to-day activities.
The touchstone under both the DOL and the IRS tests: control.
As a general rule, greater control signals an employee relationship while less control over a worker indicates an independent contractor, McCoy explained.
A company in the printing business that hires an independent contractor to run the print machine would be viewed with a high degree of skepticism, he explained, as the worker’s job is related to the core element of the business.
“Alternatively, if the same company hired a painter who came in – with his own paint, brushes, tarps, know-how and workers – he is much more likely to be an independent contractor,” McCoy said.
Other factors to consider: whether or not the individual works for other employers – the more additional clients the worker has, the better – as working for one employer full-time is indicative of employment.
“Does the individual have a federal tax ID number?” McCoy asked. “Does he have his own equipment or does he use the employer’s phone, computers, pencils and shredders?”
Any type of benefits given to the worker (vacation, retirement, health insurance) are also scrutinized, as they likely indicate an employment relationship.
One big mistake employers make: a belief in their own determination of a worker’s status.
Charlottesville attorney William C. Tucker, who represents employees, said his clients often assume that employers can simply classify them as independent contractors and do not realize they might actually be an employee, entitled to benefits and overtime pay.
But just because an employer and an individual agree that the person is an independent contractor does not make it so, as the relationship is defined exclusively by the law.
The IRS test
The 20-factor test created by the Internal Revenue Service focuses on the level of control an employer exerts over an individual in three different categories: behavioral control, financial control and relationship factors.
To qualify as an independent contractor or an employee, the worker does not have to meet each of the factors. Based on a totality of the circumstances, the weighted test is used on a case-by-case basis and no single factor is determinative of an individual’s status.
Behavioral control factors:
Instructions. If an employer can require the employee to follow instructions about when, where and how to do the work, the individual is more likely to be an employee.
Training. Independent contractors are not trained by the employer for which they provide services while employees receive initial and continuing training.
Services rendered personally. Employees cannot contract out their work but must perform it directly, with the employer controlling the method and means by which the work is accomplished.
Hiring, supervision and paying assistants. An assistant that is hired, supervised and paid by an employer is generally considered an employee. An independent contractor can hire, supervise and pay his or her own assistants.
Continuing relationship. A continuing relationship between the parties indicates an employment relationship.
Set hours of work. An independent contractor typically sets her own schedule while an employer sets an employee’s schedule.
Full time required. An individual working full time is more likely to be an employee, as independent contractors work days and hours of their own choosing.
Work done on premises. When work is performed on the employer’s premises, it is likely that the employer exercises direction and control, making the worker an employee. A worker allowed to work at her own direction to complete a job is likely to be an independent contractor.
Order or sequence set. If a business entity requires that work be performed in a specific order or sequence, that typically demonstrates control and direction over an employee. Independent contractors may select their own order or sequence of work.
Oral or written reports. A worker required to submit regular reports to the employer is likely an employee subject to control by the employer.
Financial control factors:
Payments by hour, week or month. Employees generally are paid for specific intervals of work, like hourly, weekly or monthly. Alternatively, an independent contractor is less likely to be paid at specific intervals and paid instead as aspects of the total project are completed.
Payment of expenses. An individual who is reimbursed by the employer for expenses incurred is more likely to be an employee.
Furnishing of tools and materials. Providing any necessary tools, materials or other equipment – like phones or computers – typically indicates an employment relationship.
Significant investment. A worker who makes a significant investment in the facilities where the work is performed is more likely to be an independent contractor.
Profit or loss. An independent contractor can generally make a profit or suffer a loss for performing the work at issue while an employee is typically paid for time spent completing the work and bears no liability for business expenses associated with it.
Integration. If the services performed by the individual are merely incidental to the business operation the worker is probably an independent contractor. An employee typically performs services that are integral or essential to the operation of the employer.
Working for more than one firm at a time. Does the worker perform services for multiple, unrelated business entities concurrently? If yes, the individual is more likely to be an independent contractor.
Making services available to the general public. An individual is more likely to be an independent contractor if he holds himself out to the public as being “regularly and consistently” available to perform services for anyone willing to contract.
Right to discharge. If an employer has the right to fire a worker, the individual is more likely to be an employee.
Right to terminate. A worker who can quit without breaching any contractual agreement is more likely to be an employee.