HR Management & Compliance

Factors in Classifying Contractors vs. Employees

In a previous post, we discussed the challenges rideshare company Lyft is preparing for based on its designation of drivers as independent contractors as opposed to employees.

Improper Classifications Can Represent Business Risk

It was cited by the company as a key business risk in its Initial Public Offering (IPO) prospectus. One could understandably question why a company has the latitude to make this determination in the first place. But while many traditional employment situations fall easily into one category or another, there is plenty of gray area in other cases.

Determining Proper Classifications

As the Internal Revenue Service (IRS) explains, there are three broad factors for determining the proper classification, each of which has several additional considerations:

  • Behavioral control
    • Instructions. If a worker is told when and where to work, which tools to use, etc., the relationship is closer to employer/employee.
    • Degree of instruction. The more detailed, the more likely the worker is to be seen as an employee.
    • Evaluation systems. If only the end result is evaluated, the employee is more like a contractor. If the performance of the work is evaluated, he or she is more like an employee.
    • Training. More training makes the relationship seem more like an employee.
  • Financial control
    • The following factors suggest a contractor relationship:
      • Significant investment in the equipment the worker uses
      • Unreimbursed expenses paid out of the worker’s pocket
      • Opportunity for profit or loss on the part of the worker
      • The worker’s ability to offer services to multiple companies in the market
      • Being paid a flat fee for services as opposed to a regular hourly, weekly, or annual wage
  • Relationship
    • Does the contract specify whether the worker is an employee or contractor?
      • This isn’t determinative, but it demonstrates the intent of the parties.
    • Benefits are generally not provided to contractors.
    • How permanent is the employment? A more temporary arrangement is more typical for contractors.
    • Is the work being performed by the worker part of the key business of the company?
      • If so, this weighs in favor of defining it as an employer/employee relationship.

Even with these specific factors to consider, the choice between designating a worker as an independent contractor versus designating him or her as an employee isn’t always clear-cut.

Factors from both classifications could apply to workers in a particular situation. In such cases, employers have to decide how to classify their workers. In a couple of follow-up posts, we’ll talk about the advantages of each.