Independent Contractor or Employee?

This is the question faced by many employers as they struggle to classify their workers correctly? Employment lawsuits are on the rise with employees and former employees bringing litigation on employers. In addition when the classification is incorrect there are government agencies, such as the Internal Revenue Service, and Labor Department ready to fine, and force the employer to pay back taxes, and back wages in a lump sum. The industrial commission (workers compensation) is also interested at the time of claim the status of a worker, and can affect whether a workers compensation claim is paid. In Arizona the Federal Government has added staff to both the Internal Revenue Service and Department of Labor to investigate the status of employees. You will soon see advertisements for employees to call and report any suspect violations to the government entities. Government marketing dollars have been enhanced for this purpose. History repeats itself.

Employers are often faced with classifying workers as independent contractors or employees, and if misclassified the consequences can be huge. I am asked on a periodic basis, if a worker can be classified an independent contractor, or do they have to be an employee. My answer is it depends. Titles given by employers are sometimes misleading, and do not necessarily reflect the way a worker should be classified. This is the same answer you probably would receive from a government official from one of the regulatory agencies. If called into question it will be the responsibility of the Employer to justify the classification of the worker. Classifying workers as Independent Contractors or Employees has an element of being subjective, however there are parameters that are considered by Human Resource Professionals, and Regulatory Agencies in making a determination.

Human Resource Professionals and Government Regulatory Entities consider behavior, financial control, and relationship when determining whether a worker is an independent contractor or employee. Under these three categories there are several test questions that are examined. Let’s look at a worker’s three classifications, and what will be the determining factors:

Behavior:

1. Does the worker have the ability to set their own hours, or does the company require the worker to be in the office at certain times?
2. Does the worker do their work away from the company’s office?
3. Is the worker able to determine the sequence of their work, or is this determined by the company?
4. Is the worker being paid by the job?
5. Does the worker pay for all their own tools (laptops, desk top computers, phones, and other electronic devices), or does the company furnish these tools?
6. Does the worker pay for all of their own training?
7. Does the worker hold themselves out to be self-employed or an employee of your company?

The key consideration under the behavior classification is, does the company control the details of the workers’ performance or has the company given up that right? If the worker is an independent contractor in most situations they will be able to use their own policies and procedures.

Financial Control:

1. Are the workers’ expenses unreimbursed by the employer, or does the company pay for some or all of the worker’s expenses?
2. What is the worker’s investment in their production? (An employee usually doesn’t have a financial investment other than their time).
3. Is the worker free to seek out other opportunities with other companies?
4. How is the worker paid by the company (by the week every other week, or according to a contract?)
5. Is the worker able to realize a profit or loss (an employee won’t have a profit or loss, they get paid by the company regardless )?

Type of Relationship:

1. Is there a contract between the worker and the company? This is where most of the emphasis is placed for companies who classify their workers as Independent Contractors. It is also the criteria that has the least effect with courts and regulatory agencies. The determining factor of classification when called into question will not be the words in the contract, but rather the nature of the underlying work relationship between the worker and company. In a close call of classification the contract may have a limited effect, but not carry the weight that many companies think.
2. Does the company provide benefits to the worker, (vacation pay, and sick pay, insurance? (health, disability, long term care, etc.)? An Independent Contractor pays for their own benefits.
3. Is there a permanency of the relationship between the worker and company? If there is an expectation the worker will continue with the company indefinitely rather than for a specific project it will probably be used by a regulatory agency for evidence that the relationship is that of an employee/employer.
4. To what extent are the services performed by the worker a key aspect of the company? The determining factor in this test question is what degree of independent initiative, judgment and skills will be required of the producer to perform the work? If the Company provides a large control over the worker the classification will lean heavily towards being an employee/employer relationship rather than an independent contractor.

The Internal Revenue Service (IRS) has made available a service to classify workers to determine if they are an employee or independent contractor. This can be accomplished by filing Form SS-8 with the IRS. The downside is you need to allow about six months, and this will satisfy the IRS, but it may not satisfy the Department of Labor, or if there is a question from the Industrial Commission (workers compensation).

As was stated it depends on several factors when classifying a worker as an independent contractor or an employee. Do it carefully. My e-mail is dave@idealins.com