How to Distinguish Between Employees and Independent Contractors

Date: July 20, 2016

Suppose you need someone to handle a special project. You might find an online posting or a website for someone offering to assist. In such a case you should usually be safe classifying the worker as an independent contractor—especially if we’re talking about a discrete project for something outside the usual scope of your business enterprise. For example, you might need assistance setting-up a website, or renovating your business. 

But the question of whether to classify a worker as an independent contractor becomes more difficult if you have an ongoing business relationship with a worker who might potentially claim to be your employee. The consequences of misclassifying an employee are huge. Businesses risk severe penalties for misclassification, in addition to potential lawsuits from alleged employees. For this reason the NFIB Small Business Legal Center has produced a guide to dealing with independent contractors to help businesses classify workers correctly. As explained in the NFIB Guide, it is often difficult distinguish between employees and independent contractors. For this reason some business owners err on the side of treating workers as employees. This approach may be more costly on the front-end, but can avoid the potentially catastrophic costs of litigation. Indeed, in many cases there are arguments to be made both for and against classifying a worker as an independent contractor. This is why we say it is prudent to consult a trusted employment law attorney before entering into an on-going working relationship with someone whom you intend to classify as a contractor. 

The issue is complicated because there are two separate tests for classifying independent contractors under federal law. The Internal Revenue Service applies the Common Law Test, which weighs twenty different factors. By contrast the Department of Labor applies the Economic Realities Test, which may yield different results. And further complicating matters, states agencies often apply variants of these tests, or altogether different tests. 

How Much Control Are You Exerting Over the Worker?

While the various tests to distinguish independent contractors from employees  are highly nuanced and difficult to apply with any consistency, it helps to understand that all of the various tests are ultimately aimed at a single question: How much control are you exerting over the worker? 

The more control you exert, the more likely it is that the worker will be deemed an employee. Conversely, the less control you exert over the manner and means of how the worker accomplishes the desired result (i.e., performing the contracted service), the more likely it is that the worker may be properly classified as an independent contractor.  On its face this seems simple enough. Yet in practice it may be difficult to say how much control is too much. 

The Common Law Test

The IRS and some state agencies use the twenty-question Common Law Test. No single factor is determinative. Instead a reviewing court will consider these factors cumulatively. In most cases there will be some factors that cut in favor of an independent contractor designation, while other factors may cut against that classification. Accordingly, a judge will assign greater or less weight to the different factors in light of the facts of the case—and ultimately must make a determination in consideration of the totality of circumstances.  

NFIB’s Guide to Independent Contractors provides a comprehensive analysis of all twenty factors on pages 8-9. But, to give you a flavor of the sort of questions a court will consider, you should consider the following: 

1. Are you providing instructions to the worker as to when, where and how work should be performed? 
2. Are you providing any sort of training to the worker?
3. Is the worker free to hire employees or to subcontract the project to others?
4. Is this a continuing, non-sporadic, relationship? 
5. Is the worker performing functions that are integral to your business operation?
6. Are you providing the tools and equipment for the worker?
7. Is the worker free take on other jobs while performing services for your company?
8. Does the worker pay for his or her own business expenses?
9. Does the worker’s managerial skill affect his or her opportunity for profit and loss?
10. Can either party terminate the relationship at any juncture?

Economic Realities Test

The U.S. Department of Labor and various state agencies use the Economic Realities Test to determine whether a worker should be classified as an independent contractor or not. This test asks whether the laborer is economically dependent on his or her work with your company. As with the Common Law Test, the Economic Realities Test first considers what degree of control a contracting business exerts on laborers. 

But the test stresses that a worker is more likely to be deemed an independent contractor if he or she has: (a) the opportunity for profit (or loss) depending upon how well he or she runs the business; (b) invested in his or her business facilities, tools and equipment; (c) performed work only sporadically or intervals; and (d) skills and initiative to generate business opportunities in the open market. And, as with the Common Law Test, no single factor is considered dispositive. But be aware that recent DOL guidance emphasizes that the agency is applying a presumption of employment in questionable cases

State Level Tests

Unfortunately some states require employers to comply with other—more stringent—tests. Massachusetts is probably the most egregious example. Whereas the Common Law and Economic Realities Tests allow a somewhat flexible analysis of several factors, Massachusetts law presumes that a worker is an employee unless the contracting business can prove three things: (1) the worker is free from control and direction; (2) the service is performed outside the usual course of one’s business; and (3) the worker is customarily engaged in an independent established trade, occupation, profession or business of the same nature as that involved in the service.

Similarly, the California Department of Labor Standards Enforcement (DLSE) operates with a heavy presumption that workers should be classified as employees. DLSE applies a form of the Economic Realities Test, but considers several additional factors as outlined here. And in practice DLSE seems to be more aggressive than the federal Department of Labor. For example, we’ve heard from business owners who have been hit with major penalties from DLSE for alleged misclassification of employees, while DOL concluded that those same workers were properly classified as independent contractors.  

Meanwhile other state agencies complicate matters more by applying slightly different tests. For example, the California Employment Development Department asks 13 different questions. And California’s Workers Compensation Board applies its own test, which may be described as a blending of the Common Law and Economic Realities tests. As such, it is imperative to be sure that “independent contractors” are properly classified under all of these tests—which, again, ultimately comes down to questions of how much control you are exerting over the worker. 

But rather than winging-it, business owners are advised to consult an experienced employment law attorney. Whether in California, New Jersey, or Hawaii, it’s important to understand the laws of the jurisdiction you are operating in—including the jurisdiction in which your worker is located if he or she is working remotely.

*This article does not provide legal advice. Employers are advised to retain counsel from a trusted attorney with experience in employment law.  

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