Employment law employee or independent contractor
Employment law employee or independent contractor: Many company owners are not sure if their workers are considered employees or contractors. Realizing the differences is the first step in keeping your startup or company out of hot water with the Department of Labor (DOL) and the Internal Revenue Services (IRS). A worker’s title and/or contract does not determine the status of the working relationship and classification. Knowing “what questions to ask” and “what differences to look for” are important to consider in order to correctly classify these workers. There are so many factors to consider when determining the classification of a worker including Business Relationship, the Economic Realities Test from the DOL, IRS Common Law Rules and 20 Factors from the IRS. Some factors may result in the worker being an employee, while other factors show that the worker should be labeled as a contractor.
The IRS says that the keys are to:
» Look at the entire relationship
» Consider the degree or extent of the right to direct and control
» Document each of the factors used in coming up with the determination (I can’t emphasize this enough: Protect your company with good documentation for each worker, but use the same process consistently.)
Why is it important to classify workers correctly?
Before determining if the worker is an employee or independent contractor, be aware of the reasons for correctly classifying your workers: Taxes, FLSA Rules, Affordable Care Act.
1) IRS: Differences in Taxes regarding Pay
» The IRS interpret and regulates misclassifed workers’ tax implications. The IRS uses 20 factors to ensure workers are correctly classified to ensure that companies are not trying to avoid employee tax obligations. See the 20 Factors Test at the end of the article.
» Employees: Generally, you must: withhold income taxes; withhold and pay Social Security and Medicare taxes; and pay unemployment tax on wages paid to an employee.
» Independent Contractors: You do not generally have to withhold or pay any taxes on payments to independent contractors. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax
2) Fair Labor Standards Act (FLSA) Rules
» The DOL regulates the FLSA Rules regarding properly classification employees. If an employee is incorrectly classified as an independent contractor, the company will face penalties from the DOL for not following FLSA Rules. There is no single test for determining a worker’s status under the FLSA. Under the FLSA, it all has to do with economic dependency. The DOL “generally considers” the Economic Realities Test to determine if a worker is correctly classified. See below.
» Employees: Employees receive protections under the FLSA regarding wage and hour protection (minimum wage & overtime); unemployment compensation; workers compensation coverage; FMLA; benefits and protection against discrimination and harassment.
» Independent Contractors: The FLSA does not protect independent contractors except in some states regarding discrimination & harassment.
» Penalties: In FY 2015, Wage and Hour Division investigations resulted in more than $74 Million of back pay for more than 102,000 workers.
3) Affordable Care Act
The ACA dovetails from the FLSA status: If an employee is incorrectly classified as an independent contractor, they miss out on employee benefits as well. Required coverage for employees is required for employers with 50 or more full time employees or equivalents. By incorrectly labeling employees as a contractors, the company may be avoiding the 50 requirement. The IRS, DOL and Courts do not look to kindly on this type of “mistake.”
Difference in Business Relationship
One of the most important differences is based on the business relationship. A worker’s title and/or signed contract does not determine the status of the working relationship and classification…neither is the fact that the worker may have incorporated a business for contracting purposes a factor in determining classification. Here are the Four Categories: Independent Contractor, Employee, Statutory Employee and Non Statutory Employee.
» Independent Contractor – A worker can be classified as an independent contractor if the company owner or representative has the “right to control or direct only the result of the work and not what will be done and how it will be done.”
» Employee – A worker can be classified as an employee if the company owner or representative can control what will be done and how it will be done. The worker is still consider an employee if the company owner or representative gives the employee freedom of action. The IRS states that “What matters is that you (company owner/rep) have the right to control the details of how the services are performed.”
» Statutory Employee – A worker can be classified as a Statutory Employee when they are an independent contractor that can be treated as an employee by statute for certain employment tax purposes if they (A) “fall within any one of the following four categories” and (B) “meet the three conditions described under Social Security and Medicare taxes.”
A)Companies must withhold Social Security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply.
» The service contract states or implies that substantially all the services are to be performed personally by them.
» They do not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities).
» The services are performed on a continuing basis for the same payer.
B) Four Categories of Statutory Employees:
1-A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission.
2-A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.
3-An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.
4-A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson’s principal business activity.”
Statutory Non Employee – “There are three categories of statutory non-employees: direct sellers, licensed real estate agents and certain companion sitters. Direct sellers and licensed real estate agents are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:
» Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and
» Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes.
» Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes.” IRS
Economic Realities Test
In 2015, the DOL established a test that will help to classify contractors and employees correctly. This test is the Economic Realities Test, and it contains six parts listed here:
» Scope of Work – Is the work integral to the company’s business? If their job is a vital part of the process (essential work), the worker would be an employee. If their job is not vital to the process (tangential work), the worker would be an independent contractor.
» Managerial Skills – Is the worker working independently from operations? If so, they would be an independent contractor. OR Are they being managed by the business’ operations? If so, they would be considered an employee. Also, does the worker have the opportunity to turn a profit or realize a loss? An independent contractor can charge as much as the market will allow for their work. An employee earns a certain wage regardless of the company’s wealth.
» Investment – Who owns the tools being used for the project? If the worker owns them, they are considered an independent contractor. If the company owns them, the worker would be an employee. Independent contractors invest in their own tools, computer, phone, etc.
» Special Skill-set – Does the job require special skills? Who receives the benefits from the workers’ special skill-set? If the worker uses their special skill-set for multiple companies, they are considered an independent contractor. If the worker uses their special skill-set for one company, they are considered an employee.
» Terms – How long has the worker performed for the company? If the worker has consistently worked for the company for years without breaks in work and is open ended, the worker is considered an employee. If the worker randomly works for the company in different lengths of time, they are considered an independent contractor.
» Control – Who controls the work (pay, hours, procedures, tasks, how work gets done)? Does the worker have the ability to choose if they will complete a tasks? If so, the worker is an independent contractor. If the worker cannot choose and must follow directives from the company, the worker is an employee.
The Economic Realities Test from the DOL is great for ensuring compliance with the FLSA, but you should also consider the 20 Factors test from the IRS listed below for tax implications. These factors will help you to think through each worker’s ability to control their work.
IRS Common Law Rules
The degree of control and independence must be proven through three categories of evidence:
» Behavior – Does the company control or have the right to control what the worker does and how the worker does his or her job?
» Financial – Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
» Type of Relationship – Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Sourced from the IRS: IRS 20-Factor Test: Independent Contractor or Employee?
Basic Question: Who has control over the work being done?
- Instructions – Workers who are required to comply with others’ instructions about when, where, and how they are to work are ordinarily employees.
- Training – . Training workers indicates that employers exercise control over the means by which results are accomplished.
- Integration – When the success or continuation of a business depends on the performance of certain services, the workers performing those services are subject to a certain amount of control by the owners of the businesses.
- Services rendered personally – If services must be rendered personally, employers control both the means and the results of the work.
- Hiring, supervising, and paying assistants – Control is exercised if employers hire, supervise, and pay assistants.
- Continuing relationships – . Continuing relationships between workers and employers indicate that employer-employee relationships exist.
- Set hours of work – The establishment of set hours of work by employers indicates control.
- Full-time required – If workers must devote full time to employers’ businesses, employers have control over workers’ time. Independent contractors are free to work when and for whom they choose.
- Doing work on employers’ premises – Control is indicated if the work is performed on employers’ premises.
- Order or sequences set – . Control is indicated if workers are not free to choose their own patterns of work but must perform services in the sequences set by the employers.
- Oral or written reports – . Control is indicated if workers must submit regular oral or written reports to employers.
- Payment by hour, week, or month – This points to employer-employee relationships, provided that this method of payment is not just a convenient way of paying a lump sum agreed on as the cost of a job. Independent contractors are usually paid by the job or on straight commission.
- Payment of business and/or traveling expense – Employers paying workers’ expenses of this nature shows that employer-employee relationships usually exist.
- Furnishing tools and materials – If employers furnish significant tools, materials, and other equipment, employer-employee relationships usually exist.
- Significant investments – Workers are independent contractors if they invest in facilities that are not typically maintained by employees (such as an office rented at fair market value from an unrelated party). Employees depend on employers for such facilities.
- Realization of profits or losses – Workers who can realize profits or losses (in addition to profits or losses ordinarily realized by employees) they are independent contractors. Workers who cannot are generally employees.
- Working for more than one firm at a time – If workers perform services for a number of unrelated persons at the same time, they are usually independent contractors.
- Making services available to the general public – Workers are usually independent contractors if they make their services available to the general public on a regular and consistent basis.
- Right to discharge – The right of employers to discharge workers indicates that the workers are employees.
- Right to terminate – Workers are employees if they have the right to end their relationships with their principals at any time without incurring liability.
As stated earlier, there is no set number of factors that makes a worker an employee or a contractor. Do your best to weigh both sides. Document! Document! Document how you came to your conclusion that the worker was one or the other. Best practice is to show as much detail as possible in order to cover your choices and options.
Still not sure?
If you are still not sure of the correct classification, the IRS offers assistance to make sure you are classifying employees correctly. Submit Form SS-8 to the IRS (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding). The IRS will review the form and determine the classification. Workers can also file Form SS-8 if they feel that they are incorrectly classified, so it is better to be proactive in case the worker will file before the company.
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