There's more than one test to determine if an independent contractor is actually an employee, and getting it wrong can cost you more than back pay—it can cost you your freedom.
Ready to start your business? Plans start at $0 + filing fees.
Excellent
by Diane Faulkner
Diane is a writer, speaker, and human resource consultant with over 30 years of experience working in and covering em...
Updated on: November 22, 2023 · 8 min read
Classifying workers as employees or independent contractors is a tricky business. After all, the rules change as often as the administrations in Washington, D.C.
On Jan. 6, 2021, the U.S. Department of Labor (DoL) issued its final rule clarifying who an independent contractor is versus an employee. But by May 5th, the clarification was rescinded. Earlier, the National Labor Relations Board (NLRB) eliminated three of its factors that clarified the definition of an independent contractor. Meanwhile, the IRS held fast to its two key points with nine clarifying aspects.
With all these rules and changes floating around, how are you to know how to classify work without getting into trouble?
More than one government agency has a test to define what an independent contractor is. Each has its own angle, which means that each has a slightly different focus. That said, many test factors coincide, while others contradict each other. If you make a good faith effort to clear as many factors as possible, you'll be well on your way to classifying workers correctly.
The U.S. Supreme Court has repeatedly held there is no single rule or test for determining whether someone is an independent contractor (1099-NEC) or an employee (W-2) for the purposes of the Fair Labor Standards Act (FLSA).
Rather, the Court says, "it's the total activity or situation which controls. Among the factors which the Court has considered significant are:
The Court considers immaterial:
Even though there is no one determinative factor, "the biggest factor is going to be the degree of control," says David Miklas, employment attorney with Miklas Employment Law. "The key thing for control that I usually see is if the worker:
—that looks like an independent contractor."
"On the flip side," Miklas says, "if the worker has to work long hours, maybe 50, 60, 70 hours a week, that makes it almost impossible to work for anyone else, let alone competitors, that looks like an employee. Also, if workers have to:
–that's what you do with employees."
As you might guess, the IRS is concerned about its tax base. With employees, you must withhold income taxes, pay Social Security, Medicare taxes, and unemployment taxes on all wages paid to employees. None of that happens with independent contractors. Instead, independent contractors must pay their own taxes.
The two key points the IRS says you have to keep in mind when classifying employees are:
"If you still cannot determine if a worker is an employee or independent contractor," says Talibah Bayles, founder, and CEO of TMB Tax and Financial Services, "the IRS has a form that business owners can use to let the IRS figure it out for you. It's the Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Since many small business owners do not have unionized employees, they aren't as familiar with this test. Whether or not your employees are unionized, however, these factors still apply.
Miklas describes the 10 factors:
"No one factor is decisive," Miklas says. "If you have an independent contractor bucket and an employee bucket, you're never going to get every drop of water into one bucket. You're going to have some go into each bucket. Whichever bucket is the most full, that's most likely where the NLRB will go with its findings."
There are two common questions people have when it comes to classification: Can you tell an independent contractor:
"The answer is 'sometimes,'" says Aaron Tandy, partner and head of employment law section at Pathman, Lewis. Tandy explains that you could have two painters working in an apartment complex: One on staff, the other as an independent contractor. The staff painter works from 8 a.m. to 5 p.m., Monday through Friday, wears a company shirt, and is paid a wage. The independent contractor is contracted to design and paint a mural. She works on the mural on her own schedule, but the building owner can restrict the days and times she can access the building. The building owner can also give her a company shirt to wear, so residents are not alarmed that this stranger is painting in the building. She gets paid by invoice to turn over the copyright for the image she created to the company. As you can see, things aren't always clear-cut.
The most common way companies get into trouble with misclassification is by not paying overtime. To save money, they'll wrongly misclassify employees as independent contractors to specifically not pay overtime. They also save money because they don't have to pay taxes on independent contractors, can't get sued under most of the discrimination laws, and don't have to deal with unions.
"I usually see it where someone wants to save as much money as possible, and [the company] works people 50, 60, 70 hours a week and won't pay overtime because they've misclassified [the people]," says Miklas. Then they get caught. "Now they're on the hook for back pay, which can be extraordinarily high. And most likely, if you've misclassified one person, you've misclassified an entire group. These aren't $2,000 settlements. They could be significant enough to bankrupt a company." Plus, misclassifying employees is a federal offense, so there can also be jail time for the company owner.
Once an employer is caught in an investigation by any one of the three government agencies—usually for not paying overtime—they can expect to be investigated by other agencies, possibly state and local government agencies, too. This is because many agencies have work-sharing agreements with each other. The U.S. Department of Labor, for example, has a work-sharing agreement with the Florida Department of Revenue. If one is investigating you and finds evidence of wrongdoing, they'll notify the other. "As part of that," says Miklas, "they'll make a referral of a complaint, and then they'll coordinate their investigations and even cooperate with criminal investigations."
Investigations can go back two years. If there are willful violations, investigators will go back three years. Then they keep coming back every two years.
"The biggest problem," says Miklas, "is that people don't seek legal advice. They don't want to know they're doing it wrong, and when they get caught, they just want to get out of trouble. At that point, you're just writing a check."
With the new administration's focus on making it difficult to be classified as an independent contractor, "there are going to be more challenges," Miklas warns. "Now's the time companies should be auditing [themselves] and making sure these people really are independent contractors."
You may also like
What Does 'Inc.' Mean in a Company Name?
'Inc.' in a company name means the business is incorporated, but what does that entail, exactly? Here's everything you need to know about incorporating your business.
October 9, 2023 · 10min read
How to Get an LLC and Start a Limited Liability Company
Considering an LLC for your business? The application process isn't complicated, but to apply for an LLC, you'll have to do some homework first.
October 3, 2024 · 11min read
How to Start an LLC in 7 Easy Steps (2024 Guide)
2024 is one of the best years ever to start an LLC, and you can create yours in only a few steps.
July 29, 2024 · 22min read