Independent Contractors

The Department of Labor (DOL) has been very aggressive in auditing employers over the misclassification of workers as independent contractors, instead of employees.  Properly classifying workers is important for employers to avoid hefty fines, additional taxes, interest, and additional wage and overtime obligations.

The old test focused on the employer’s control over the worker.  Since 2015, the DOL has applied an “economic realities test,” to determine whether the worker is economically dependent on the employer.  The test asks six questions to determine a worker’s proper employment status.  They are:

  1. Is the work to be performed integral to the operation of the business? If the work is integral to the business of the employer, the worker is economically dependent on the employer and therefore considered an employee.
  2. Does the worker’s managerial skills affect their opportunity for profit and loss? This is generally determined by whether or not the worker has the ability to make decisions and use their managerial skill and initiative to impact their profit and loss.
  3. How does the worker’s relative investments in facilities and equipment compare to the employer? Under this test the worker must make an investment and bear some risk of loss in order to be an independent contractor in business for themselves. Examples of investments might include the purchase of a specialized business vehicle, advertising for the business, rented office space for the business, etc.  The investment can’t be minor and needs to be compared to the employer’s investment.
  4. Does the work require special skills and initiative? To qualify as an independent contractor, the worker would need to exhibit independent business judgment. Business judgment must be used in some independent manner which demonstrates initiative.  These may include marketing the business, ordering supplies and equipment for the business etc.
  5. Is the work relationship indefinite? Indefiniteness in the working relationship makes it appear more likely the worker is an employee. Generally, an independent contractor relationship is evidenced by a contract for a limited period of time or a special project.
  6. What is the nature and degree of the employer’s control? Analysis of this factor takes into consideration who sets the amount of and hours of work, who determines how the work is performed, as well as whether the worker is free to work for others and/or hire helpers.

The DOL has specifically stated however, that the fact a worker has incorporated a business and/or is licensed by a state or local government has little bearing on determining the nature of the employment relationship.  Similarly, the mode or time of the payment to the worker is not determinative.

Since the DOL has declared most workers are employees under their broad definition, it is a good time for employers to review their independent contractors, to determine if they in fact are misclassified.  Getting it right will save a lot of time, effort, and money.

Employers need to be careful and not misclassify employees as independent contractors in an effort to avoid income taxes, Social Security and Medicare taxes, as well as, unemployment taxes.

In deciding whether someone providing a service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. The general rule is that an individual is an independent contractor if an employer has the right to control or direct only the result of the work and not the means and methods of accomplishing the result. The common-law rule for an employee is, if you can control what work will be done and how it will be done, the individual is an employee. The IRS provides a nice breakdown on what to consider when determining if a person is an employee or independent contractor.

As Dennis Westlind from the World of Work Law blog highlights, ‘It is always risky to misclassify someone who should be an employee as an “independent contractor,” but it will become even riskier for employers in 2011 if President Obama’s budget proposal is passed by the legislature.’
The federal government loses millions of dollars of payroll tax revenue annually due to the misclassification of employees as independent contractors. President Obama’s budget proposal has earmarked funds to target this type of misclassification.

Don’t let your business get caught with misclassified employees. Review the business relationship between you and anyone currently classified as an independent contractor to prevent any litigation or penalties for your business.