Perhaps the most common type of nontraditional worker in the new workforce is the independent contractor. The recession saw many people seeking work as independent contractors and as the economy has improved, these relationships have continued, whether due to the preference of the employer, the employee, or both.
But simply designating workers as “independent contractors” isn’t enough to ensure they pass the IRS and U.S. Department of Labor (DOL) tests for designating someone an independent contractor instead of an employee.
To determine whether a worker is an employee or an independent contractor, the IRS considers three categories of factors related to the degree of control and independence you have over the worker:
- Behavioral control refers to facts that show whether you have a right to direct or control how the worker does the work. A worker is an employee when the business has the right to direct and control the worker. A worker is likely an employee if he or she is subject to the business’s instructions about when, where, and how to work.
- Financial control refers to facts that show whether or not a business has the right to control the economic aspects of the worker’s job. If the worker incurs significant unreimbursed expenses, has a major investment in the business, provides the tools or supplies to do the job, and is available to work for other companies or clients, he or she is more likely to be an independent contractor.
- Type of relationship refers to facts that show how the worker and business perceive their relationship. For example, providing the worker with traditional employee benefits like insurance, pension plans, paid vacation, sick days, and disability insurance might indicate that the person should be classified as an employee. The lack of such benefits, though, doesn’t necessarily mean the worker is an independent contractor. A person who signs a written contract to perform specific work looks more like a contractor, although having a contract is not definitive. The IRS also considers whether the relationship is expected to continue indefinitely or is for a distinct project or a limited period of time. And if a worker provides services that are a key aspect of the employer’s business, it is more likely that the business will have the right to direct and control the worker’s activities.
The DOL’s primary concern regarding misclassification is compliance with the Fair Labor Standards Act (FLSA). Guidance from the DOL makes clear that in the DOL’s opinion, most workers will be classified as employees. The guidance explains that for the FLSA’s minimum wage and overtime provisions to apply to a worker, the worker must be an “employee” of the employer. The FLSA definition of “employ” includes “to suffer or permit to work,” representing the broadest definition of employment under the law because it covers work that the employer directs or allows to take place.
A number of “economic realities” factors help resolve whether workers are truly in business for themselves or are economically dependent on an employer that can require (or allow) employees to work and that can prevent employees from working. The factors considered can vary, and while no one set of factors is exclusive, the DOL generally considers the following factors when determining whether a worker is an employee covered by the FLSA
- The extent to which the work performed is an integral part of the employer’s business. Similar to the IRS test, if an individual’s work is integral to the employer’s business, it is more likely that the worker is an employee rather than in business for himself or herself.
- Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Managerial skill may be indicated by the hiring and supervision of workers or investment in equipment. Analysis of this factor focuses on whether the worker exercises managerial skills and, if so, whether those skills affect his or her opportunity for both profit and loss.
- The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment (and bear some risk for a loss) in order for there to be an indication that he or she is an independent contractor in business for himself or herself.
- The worker’s skill and initiative. To indicate possible independent contractor status, the worker’s skills should demonstrate that he or she exercises independent business judgment. Further, the fact that a worker is in open-market competition with others would suggest independent contractor status.
- The permanency of the worker’s relationship with the employer. Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee.
- The nature and degree of control by the employer. Analysis of this factor includes who sets pay and work hours and who determines how the work is performed, as well as whether the worker is free to work for others and hire helpers.