Up to 30 percent of employers misclassify their employees as independent contractors, according to national estimates. Misclassification occurs when an employer improperly classifies a worker as an independent contractor instead of an employee. Unfortunately, the consequences can be severe. Some businesses intentionally misclassify workers to try to save on taxes or avoid other costs associated with having employees, but the mistakes can be unintentional as well.
Key Factor May Be Level of Control
Distinguishing between an employee and an independent contractor, although complicated, is important, and there are multiple factors you should evaluate before classifying a worker. When determining a worker’s classification, keep the following IRS quote in mind:
There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.
The simplest standard may be evaluating the level of control you have over the worker. If you have the right to control the work (i.e., how, where, or when it’s completed) and provide the worker with tools and equipment to finish it, the individual should probably be classified as an employee, not an independent contractor.
On the other hand, if you determine the task to be performed but the worker controls when, where, or how, she may properly be classified as an independent contractor. Why? Because independent contractors are just that: independent.
The employer partners with independent contractors to define the scope of the work, but it doesn’t control how the work is completed. Independent contractors generally set their own schedules, can work off-site, and use their own tools and equipment.
Helpful Tests
The independent contractor tests employed by the IRS and the U.S. Department of Labor (DOL) provide useful guidelines for employers.
IRS test. The IRS considers three categories when classifying independent contractors:
- Behavioral control: Does the company control (or have the right to steer) what the worker does and how she does the job?
- Financial control: Are the business aspects of the worker’s job controlled by the payer? (The factors include how the worker is paid, whether expenses are reimbursed, and who provides the tools or supplies.)
- Type of relationship: Are there written contracts or employee-type benefits (e.g., pension plan, insurance, or vacation pay)? Will the relationship continue, and is the work performed a key aspect of the business?
DOL test. Similarly, the DOL uses an “economic reality test” to determine who is an employee: “An employee, as distinguished from a person who is engaged in a business of his or her own, is one who, as a matter of economic reality, follows the usual path of an employee and is dependent on the business which he or she serves.” The test considers seven characteristics:
- Extent to which the rendered services are an integral part of the principal’s business;
- Permanency of the relationship;
- Amount of the alleged contractor’s investment in facilities and equipment;
- Nature and degree of control by the principal;
- Alleged contractor’s opportunities for profit and loss;
- Amount of initiative, judgment, or foresight in open market competition with others that’s required for the success of the claimed independent contractor; and
- Degree of independent business organization and operation.
The IRS and the DOL tests, although different, both attempt to determine the extent to which a worker is truly independent versus independent in name only.
Penalties Can Be Heavy
Penalties for worker misclassification can be severe. Ramifications vary depending on the IRS’s or the DOL’s determination of whether the action was unintentional, intentional (willful), or fraudulent. Consequences can include costly fines, violations of federal and state labor laws, and criminal penalties.
It’s important for you to classify workers properly. To do so, you must have a clear understanding of the relationship between your business and the workers. As every situation is different, a qualified attorney can help you analyze your individual circumstances and ensure you’re following the law.
Gregory H. Gunn is an attorney with Parsons, Behle & Latimer. You can reach him at 801-532-1234 or ggunn@parsonsbehle.com.