When Should a Worker Be Classified as an Independent Contractor?
Workplaces are changing shape. Historically, most businesses would rely on the work of full-and-part-time employees but a changing landscape has seen an increased reliance on the services of contract work.
Understanding the different types of workers your business employs or works with and properly classifying them are critical compliance elements businesses need to be on top of. The increased reliance on contract work along with the prevalence of freelancers and the self-employed has created additional questions in classifying these workers.
Although classifying workers as independent contractors may seem common practice, businesses should not rely on industry standards and must carefully evaluate proper classification in order to avoid severe penalties for misclassification.
What is an Independent Contractor?
Whether an individual can be properly classified as an independent contractor (and forego the rights and protections afforded to employees) requires an individualized, fact-based analysis. Different agencies use varying tests to determine whether an individual is properly classified as an independent contractor, and many tests may apply. The tests do share some common characteristics, each of which generally addresses how much control the business has over the manner and means of performing the work, as opposed to just the outcome or the deliverable.
For example, the U.S. Department of Labor and courts have developed the “economic realities test” to determine if an employment relationship exists under the Fair Labor Standards Act. This test considers an individual’s specific work circumstances and no single factor is dispositive. Courts analyze the relationship between the parties and use a balancing test to evaluate the degree of control the company has over the worker performing the services, the relative investment in facilities, the worker’s opportunity for profit and loss, the permanency of the parties’ relationship, and the skill required. Many courts also look to whether the worker’s services are integral to the company’s business.
Essentially, if the individual charges fees to do work for your business, does not work regularly for your company but is engaged for specific projects, and is able to freely do the work however they please to produce the result you are paying for, they likely can be classified as an independent contractor. However, if the individual is hired to do the same type of work that employees do for the company or to perform work that is an integral part of the business model (such as the lawyers and paralegals working for a law firm, as opposed to a cleaning service hired to maintain the office space), the individual may be an employee. Simply calling a worker an independent contractor or even entering into an independent contractor agreement with the worker, does not necessarily mean the individual has been correctly classified, and the company could still risk penalties for misclassification.
Benefits of Engaging Independent Contractors
Organizations that enlist the services of independent contractors have fewer financial responsibilities to those workers compared to employees. For instance, independent contractors are not governed by state or federal minimum wage laws. Instead, contractors set their own rates and fees to provide services to the business, such as charging a certain rate by square footage to clean an office space.
Independent contractors are generally responsible for their own insurance and for the cost of tools and materials necessary to perform the work. Independent contractors will market their own services and are responsible for the costs involved with running their independent businesses, including any registrations and permitting required. In addition, since the independent contractor has complete control over how they perform the services, the business is not responsible for (and should not engage in) onboarding or training the worker.
Consequences of Misclassifying Independent Contractors
Businesses should carefully consider the relationship between the company and the worker before classifying the worker as an independent contractor since penalties for misclassification can be significant.
If a court or agency determines that an employee was misclassified as an independent contractor, the business may be liable for back pay, including overtime compensation, employee benefits, including stock options, retirement benefits, health plan coverage, disability payments, and workers’ compensation, tax and insurance obligations, liquidated damages, and civil monetary penalties.
Minimizing the Risks of Misclassification
Minimizing the risk of misclassification will be imperative to keep your business in compliance moving forward and to avoid severe penalties. There are a number of ways you can start doing this today.
First of all, all members of leadership who have the power to enter contracts with independent contractors should be trained and educated on these classifications. This ensures that a member of your organization does not unknowingly jeopardize the integrity of the entire company.
Additionally, companies should consider doing an audit of all independent contractor work in recent years. This issue has come more into focus and assuming workers are properly classified based on industry standards or even the intent of both parties could be a mistake. Even if an individual expresses a preference for the autonomy of an independent contractor role, there is still risk that a court or government agency will find the individual was misclassified depending on specifics of the particular situation and the nature of the relationship between the parties.
Lastly, you can take the extra step to fill out Form SS-8 with the IRS which officially defines a worker’s status for federal employment taxes and income tax withholding. This can be an extensive process, but you significantly mitigate the risks of misclassification in doing so.
Don’t get caught up misclassifying workers your business works with. The team at White Summers can evaluate the unique needs of your business and help you stay in compliance with worker classification as changes continue to be made.
By White Summers