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Employee or Independent Contractor: Employer Guidelines

Are you finding it difficult to differentiate between employees and independent contractors? Well accurately defining a worker’s classification status may be a more serious issue than you might have anticipated. The U.S. Department of Labor (DOL) released the 2012 proposed budget, which emphasized a strong focus on identifying employers who misclassify workers as independent contractors versus employees. The DOL requested an additional $46 million to support a multi-agency initiative with the Wage and Hour Division (WHD), the Office of Federal Contract Compliance Claims (OFCCP) and the Occupational Safety and Health Administration (OSHA) to combat employee misclassification. In recent years, the DOL has “cracked-down” on employers for intentionally misclassifying employees as a means to escape payment of employment taxes, overtime compensation, and benefits.

 An employee is an individual, who is employed by one employer that provides training and control on how duties are performed. However, independent contractors operate under their own business name and may employ other workers to work under their direction. When a worker is classified as an employee, the employer is responsible for paying payroll taxes and overtime compensation, as well as complying with Wage and Hour law requirements such as providing meal periods and rest breaks and reimbursing workers for business expenses. Additionally, employers must cover employees under their worker’s compensation insurance, and are liable for payment of unemployment insurance, disability insurance and social security.

There is no universal system to differentiate between employees and independent contractors.

The DOL recommends using the “Economic Realities” Test. Defining factors are based on :
  • Degree of control in regards to the way work is done and the nature of control
  • Opportunities for profit or loss
  • Investment in the facilities and equipment of the business
  • Permanency or length of relationship with business
  • Degree of skill need to perform their job
  • Impact work performed has on scope of business
IRS uses the common law test known as the “Right-to-Control” Test
  • Level of instruction
  • Amount of training
  • Degree of business integration
  • Extent of personal services
  • Control of assistants
  • Continuity of relationship
  • Flexibility of schedule
  • Demands for full-time work
  • Need for on-site services
  • Sequence of work
  • Requirements for reports
  • Method of payment
  • Payment of business or travel expenses
  • Provision of tools and materials
  • Investment in facilities
  • Realization of profit or loss
  • Work for multiple companies
 Consequences of Misclassification
  • Misclassification of an Employee – If the employer mistakenly classifies an employee as an independent contractor, the employee can recover back pay, liquidated damages and attorney’s fees. According to the Fair Labor Standard Act (FLSA), employers are required to pay employees at least minimum wage (currently $7.25) for each hour worked. Employees must receive overtime compensation for all hours worked exceeding 40 hours in a workweek, at a minimum of one and a half times the regular pay rate. Employees have up to two years to seek recovery of back pay or three years if there is proof of willful FLSA violation by the employer.
  • Misclassification of an Independent Contractor– Employers could encounter financial consequences if the worker is classified as an employee instead of independent contractor. Employers could be paying unnecessary income tax, Federal Insurance Contribution Act (FICA) tax and Federal Unemployment Tax (FUTA) as well as overtime compensation and excessive benefit charges.
HR Best Practices
  • Perform a Classification Audit – A well executed classification audit will reveal gap areas that can potentially lead to costly legal disputes and government fines. Classification audits also serve as good faith evidence for compliance with FLSA.
  • Use IRS Form in case of Confusion in Determining the Status – When the status of a worker is unclear, employers are encouraged to complete IRS Form SS-8  and submit the form to the Internal Revenue Service (IRS). The IRS will review the facts and circumstances and officially determine the worker’s status. This form may be filed by either the business or the worker.
  • Seek External Resources – It may be best to seek the assistance of legal counsel or consult an HR outsourcing provider if  classification of  an employee’s status becomes too complex.