Founders, are you hiring Independent Contractors or Employees?

You need to know the difference.

When a business needs help getting the job done, it often turns to independent contractors (ICs). In fact, from 2005 to 2015, the number of Americans working as ICs rose by 9.4 million, an increase greater than the rise in overall employment. This dramatic shift in the way work is provided is at the heart of what has become known as the gig economy. But should these workers in their various gigs be treated as employees?

Businesses have plenty of reasons to classify workers as ICs rather than employees. To begin with, from a regulatory standpoint, ICs are not protected by most state and federal statutes impacting the workplace. These statutes include the federal Fair Labor Standards Act (FLSA), Americans with Disabilities Act (ADA), National Labor Relations Act (NLRA), Family and Medical Leave Act (FMLA), Affordable Care Act (ACA, aka Obamacare) and Occupational Safety and Health Act (OSHA), each of which only apply to employees and/or businesses with the requisite number of employees. In addition, businesses are not required to provide workers compensation coverage, pay unemployment premiums, reimburse business expenses, withhold income tax or contribute towards Social Security or Medicare on behalf of ICs. So why would any business classify a worker as an employee?

Businesses do have incentive to classify all workers as ICs, and the agencies that are tasked with enforcing the statutes and obligations mentioned above have begun to increasingly focus their efforts on challenging misclassifications. For instance, the Internal Revenue Service (IRS) wants more tax dollars, the U.S. Department of Labor wants to protect the right of individuals to receive minimum wage and overtime compensation under the FLSA, and the National Labor Relations Board wants individuals to be able to join labor unions and engage in protected concerted activity under the NLRA. Most importantly, penalties for misclassifying workers can be substantial and devastating to a business’ bottom line.

So how does a business ensure its classifications are correct? It’s more than just issuing the worker a Form 1099 each year or having him/her sign an Independent Contractor Agreement. Neither provide the legal protection a business really needs. In many cases, which test is used depends upon which agency is questioning a worker’s classification. For example, the “Common Law Test” is used by the IRS and some courts. It includes the following:

• The most critical factor is the right to direct or control the means and methods of how the work is to be done. The more control retained by the business, the more likely the worker is an employee.

Other relevant factors include:

• How the worker is paid — by the hour is more likely an employee.
• Who provides equipment/tools — an IC should provide their own.
• Whether expenses are reimbursed — an IC should pay their own.
• Length of the relationship — the longer, the more likely an employee
• Whether the work is critical to the business — the more critical, the more likely an employee
• Ability to work for others — IC’s should not be prevented from working for others

The DOL uses what is known as the “Economic Realities Test,” which is intentionally broader than the Common Law Test since it is based upon the FLSA’s definition of “employ” as “to suffer or permit to work.” The central question under this test is whether the worker is economically dependent on the business or is in business for him or herself? Similar to the Common Law Test, the factors for this test typically include:

• The extent to which the work performed is an integral part of the company’s business
• The worker’s opportunity for profit or loss depending upon his or her managerial skill
• The extent of the relative investments of the business and the worker in the work
• Whether the work performed requires special skills and initiative
• The permanency of the relationship, and the degree of control exercised or retained by the business

It’s important to keep in mind that under either test no single factor is determinative. Look at the entire relationship as a whole before deciding how to treat the worker.

Finally, as part of its efforts to address this critical issue as the gig economy continues to expand, the DOL has created a user-friendly webpage where workers, businesses, and government agencies can find information and resources: www.dol.gov/misclassification.

The information contained in this post should not be considered legal advice, nor does it establish an attorney-client relationship between the author and the reader. Readers should to seek the advice of legal counsel before taking any action based upon the content of this post.

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