HR Management & Compliance

Independent contractor or employee? Ensure you get it right

How do you know whether to classify someone as an independent contractor or employee? Is it enough to have a contract in place that specifies that someone is not considered an employee? While most employees hope they have it right, misclassifying employees as independent contractors costs the federal government $2.72 billion every year, according to their accountants. Last December alone, 30 percent of employers using independent contractors misclassified them. Are you one of them?

Independent Contractor or Employee Misclassification: What’s the Problem?

More companies today are using people treated as non-employees. These may be known by any number of names, such as contract labor, contract employees (which is an oxymoron), owner/operators, freelancers, or independent contractors. Whatever the label, are they really “employees” under the law? Many legal areas come into play here – including federal, state, and local tax laws; wage and hour laws; other employment laws; workers’ compensation laws; and unemployment compensation laws.

Government officials have become concerned about the loss of (or delay in) tax revenue, and the loss of employment contributions such as inclusion in employee benefit plans. They’re also concerned about employer compliance under employment laws, especially wage and hour laws. For all these reasons, investigations and enforcement are on the rise, and new laws have been proposed to combat misclassification such as the Employee Misclassification Prevention Act. There have also been strengthened penalties at the state level and “task force” initiatives created in which federal and state governments are working together for enforcement.

Independent Contractor or Employee Classification: Getting it Right

When considering whether someone should be classified as an independent contractor or employee, how do you make the final determination? The US Department of Labor (DOL) does offer some information, which was outlined in a recent CER webinar titled “Exempt or Nonexempt? Determining Employee Classification and Overtime Compensation.” Attorney John Skousen explained that the DOL and courts consider things like:

  • To what extent the individual’s work is an integral part of an employer’s business or services. “If you’re in a business that makes widgets and you hire supplemental individuals to assist you with some component of that production work, they’re probably going to be an employee – not an independent contractor – no matter what you call them.” Skousen told us.
  • The amount of the individual’s investment in facilities and equipment (if any).
  • Whether the individual has any real opportunities for profit and loss (not just how hard, how long, or how well he or she works).
  • Whether the individual exercises initiative, judgment, foresight, skills, and initiative in a business sense.
  • Whether the relationship is permanent or indefinite.
  • What level of meaningful control the individual exercises, compared to how much control the alleged employer exercises or can exercise.
  • Whether the contractor’s work is the same as or similar to that done by acknowledged employees.
  • Whether the training, supervision, and other oversight exercised over the contractor is the same as or similar to those for acknowledged employees.
  • Who provides the facilities, tools, equipment, and supplies used.
  • Whether the contractor is required to purchase equipment or supplies from a particular vendor or supplier.
  • Whether the alleged employer “finances” the contractor’s purchase of the facilities, tools, equipment, and supplies to be used, or protects him or her against capital loss.
  • Whether pay is set by bidding or true negotiation, or if there a minimum guarantee.
  • Whether the alleged employer establishes a territory or route for the contractor.
  • Who controls which assignments, and how many assignments the contractor carries out.
  • Who sets customer prices, terms of service, the hours of business and work.

Remember that no one single factor controls which classification – independent contractor or employee – is correct; instead it depends upon the circumstances of the whole activity. “Consider as it a sliding scale: you have clear independence at one end, and obvious employment status at the other. In the real world we all know: most situations are somewhere in-between. You have to decide what level of risk.” Skousen advised.

Employers must be realistic and ask themselves whether the situation is suited for using independent contractors at all. Does the need for control, along with other operational, managerial, and practical concerns, mean that the answer is no? Either way, to stay in legal compliance, the classification needs to be right.

To register for a future webinar, visit CER webinars.

John Skousen is a partner in the Irvine, California, office of Fisher & Phillips LLP ( His law practice is concentrated on wage and hour law, compliance training, and employment litigation.

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