Independent Contractor Misclassification


contract and pen

The internet and mobile applications have completely revolutionized the way companies do business. In turn, a new and increasingly popular business model has emerged – the gig economy, also known as, the on-demand economy. This business model allows business owners the opportunity to avoid all of the red-tape that comes with hiring employees. Instead, the business owners rely on independent contractors as the primary service provider. By utilizing this model, companies are able to avoid significant tax and other liabilities every year. While this is an extremely smart business model that may yield savings for a company, improper classification may result in a compliance nightmare and have detrimental legal consequences for the business owner. The cost of worker misclassification can be detrimental to your business and result in steep penalties.


It is a misconception that simply referring to a worker as an independent contractor in a written agreement will protect a business from a legal challenge regarding the status of their workers. Further, a worker is not properly classified as an independent contractor just because the work is part-time, seasonal, or for a trial period. Over the last several years, federal and state enforcement efforts have resulted in a steady increase in agency audits and class and collective action lawsuits. So, it has become increasingly more important for businesses to understand the laws that determine a worker’s status.


This post will provide you with a fundamental understanding of the tests that various courts and government agencies use to determine whether the contractor is correctly classified as an independent contractor so that you may assess whether your current working arrangement qualifies.


RIGHT TO CONTROL TEST: Internal Revenue Service


There are several tests used to determine whether independent contractors are properly classified. The IRS and some courts utilize, the right to control test which focuses on the degree of control the company has over the worker performing the service. In an employment relationship, the employer controls the manner and means by which employees perform their work. In an independent contractor relationship, the contractor controls the work. The company controls the result, not how the work is performed. The right to control is the primary focus of this inquiry, not whether the company actually exercises that control. Some examples of control over the manner and means of the work include: Although no one factor is determinative, the IRS’s test considers several factors grouped into three general categories:

  1. Behavioral Control - The behavioral control factor takes into consideration how much control a hiring entity has over the assignment to be completed as well as the manner in which the assignment is done. In general, if a worker is provided strict guidance on how, when, and where to complete the assigned task, then the worker is generally considered to be an employee. Whereas, if the worker does not require training or guidance and completes the work in accordance with their own standards and set their own schedule, they are typically considered an independent contractor.

  2. Financial Control - Financial control considers whether a hiring entity has the right to control or direct the business and financial aspects of the worker’s job. For instance, typically, an independent contractor will incur unreimbursed expenses. In addition, independent contractors will generally provide their own tools or equipment. But, employees will rely on their employer to provide anything additional. Another factor considered is how payment occurs. Employees are paid a regular wage in exchange for working for a specific time period, while contractors are generally paid a flat fee for the duration a project. Also, independent contractors are free to market their services to other businesses and will incur a profit or loss.

  3. Relationship of the Parties - A contractual agreement which defines the relationship between the hiring entity and the worker and details the project or task to be completed will generally help to determine the relationship of a business with a contractor. Conversely, if a worker has been hired or engaged for an indefinite period of time, provided with benefits such as overtime pay, vacation, and health insurance, then the worker is more likely an employee. In addition, an examination of whether the services provided are key aspects of the business can provide some insight into the relationship. If the worker’s services are a key aspect, then it is more likely that the worker is an employee of the hiring entity rather than an independent contractor.

These factors are not to be considered in isolation and no one factor is determinative. It is the broader picture or the totality of the circumstances that determine the relationship between the parties.


THE ECONOMIC REALITIES TEST: THE DEPARTMENT OF LABOR’S STANDARD


The Department of Labor’s (“DOL”) Fair Labor Standards Act (“FLSA”) defines employee as "any individual employed by an employer" who is "suffered or permitted" to work. Unfortunately, this vague statutory definition is useless. With little guidance from the statute, the DOL and the courts have developed the economic realities test to determine whether an employment relationship exists under the FLSA. The primary focus of this test is whether the economic realities of the parties' relationship are such that the worker is economically dependent on the hiring entity or is in business for themselves.


Contractual language, the worker's title or label, and common law factors evaluated in isolation do not define the relationship. Courts analyze the totality of the parties' relationship and nearly all use a balancing test to evaluate various factors, including the following six factors:


The DOL states that a number of nonexclusive and non-determinative factors are helpful guides, including:


1. The extent to which the work performed is integral to the hiring entity's business. If so, it is more likely the worker is economically dependent on the hiring entity and is an employee. The DOL’s position is that a true independent contractor's work is unlikely to be integral to the hiring entity's business.


2. Whether the worker's managerial skill affects their opportunity for profit or loss. A worker that is in the business for themselves has the ability to incur a profit or a loss. The worker's ability or decision to work more jobs or more hours it not considered to be a managerial skill and is therefore not considered in this analysis. To be properly classified as an independent contractor, the worker's managerial skills must include their decisions concerning: