This is an interpretation of the DOL and IRS regulations for determining an independent contractor. It is intended to be used for informational purposes only and not considered legal advice.

While people often ask to be Independent Contractors for various reasons typically personal tax write-offs or it can be tempting to make a worker an Independent Contractor to save money on taxes or hassle with new hire paperwork, immigration issues, etc., there are several factors a company should consider. According to the DOL, IRS, and Homeland Security, the misclassification of employees as independent contractors is a growing problem that needs to be brought under control. Under the DOL’s new guidance, the vast majority of workers will be considered employees.

If a worker is determined that they should have been classified as an employee vs independent contractor the employer will be responsible for back taxes not withheld, fines, possible ACA violations, penalties local, state, and federal, plus significant exposure for benefits forfeited that should have been due such as medical insurance, workers comp, unemployment, and retirement benefits and earnings loss. In several states, cities, and local counties they have implemented a 3x penalty clause and consider this “wage theft”. It is also possible to have criminal charges filed for tax fraud. Below is a summary of the DOL’s guidance and some steps employers can take to reduce the chance of an investigation or lawsuit.

As explained in the DOL’s guidance, the focus of the economic realities test is on whether the worker is economically dependent on the employer or truly operating an independent business. The economic realities test requires the following six factors be considered together to determine whether a worker is an employee or independent contractor. No one factor is dispositive, especially the right to control the worker’s work.

____ a) Is the work an integral part of the employer’s business? A worker’s work will be integral to the employer’s business even if it is only a small part of the employer’s business. Are there other similar positions that are regular employees in the company? Work need not be performed on company premises to be integral.

____ b) Does the worker’s managerial skill affect his opportunity for profit or loss? This factor looks at whether the worker uses managerial skill and initiative to affect the opportunity for profit or loss, not whether the worker can work more or fewer hours at his discretion. Some things to consider are whether the worker hires others to assist him, advertises and markets his services, chooses and purchases materials and equipment, negotiates contracts, rents space and sets time tables for his work.

____ c) How does the worker’s relative investment compare to the employer’s investment? This factor requires employers to consider not just the worker’s investment alone, but how it compares to the employer’s investment. A worker’s relatively minor investment compared to the employer’s investment suggests economic dependence on the company which is indicative of employee status. Examples include does the employer provide the independent contractor equipment such as a laptop, cell phone, tools, etc.

____ d) Does the work require special skill or initiative? This factor does not relate to the worker’s technical skills, but to the worker’s business skills, judgement and initiative. When analyzing this factor, employers should consider things such as whether the worker engages in marketing and promoting their own services, choosing his materials, and determining how and when to fill his orders.

____ e) Is the relationship between the worker and the employer permanent or indefinite? While a permanent or indefinite relationship will often favor employee status, employers need to look at the reasons why the relationship is permanent or indefinite. For example, if it is the result of the worker’s independent business initiative to gain more business for their own profit, this will likely favor independent contractor status. However, if it is merely related to the particular characteristics of the industry, such as the need for seasonal work, this factor will weigh in favor of employee status.

____ f) What is the nature and degree of the employer’s control over the employee’s work? The DOL explained that this factor should not be given undue weight. This requires an analysis of the worker’s actual, not theoretical, control over meaningful aspects of his work. There should be little to no control of the work required. The fact that a worker controls the hours he works or works from home should have little impact.

In conjunction with the DOL Economic Realities test the IRS also has their own test. Check below if you pass test.

____ 1. Instruction – Independent contractors do not receive detailed instructions on how to perform and accomplish a specific job or task.

____ 2. Training – Independent contractors do not receive training from the employer to do a job. It is expected that they bring a certain level of expertise to the job.

____ 3. Personally rendered services – Independent contractors usually have the right to hire employees or contract with other entities to perform the actual job.

____ 4. Controls over assistance – Independent contractors are generally free to decide whether or not to hire assistance to accomplish the job and to control their work activities.

____ 5. Work hours and schedule - Independent contractors generally have control over their work hours and schedule for accomplishing the results.

____ 6. Work requirement - Independent contractors are free to work when and for whom they choose. A requirement to work part or full-time indicates employer control, not a contractor.

____ 7. Work location - Independent contractors generally have the right to choose where the work will be performed.

____ 8. Required work order or sequence - Independent contractors determine the order and sequence in which they will perform the work.

____ 9. Required reports – A degree of control is suggested if a worker is required to submit regular oral or written reports, therefore they would not be a contractor.

____ 10. Payment - Independent contractors are generally paid by the job. Employees are usually paid salary or by the hour, day, week, or month.

____ 11. Business expenses - Independent contractors are generally responsible for their business expenses, included in the job pricing.

____ 12. Tools and material - Independent contractors usually provide their own tools, materials and equipment to perform the job such as laptops, cell phones, email address, etc.

____ 13. Investment in facilities – Workers are more likely to be treated as an independent contractor if they have a significant investment in facilities and marketing in the course of performing their job.

____ 14. Profit or loss - Independent contractors usually realize a profit or sustain a loss based on the success in performing the work or service.

____ 15. Business succession continuation – Operations or ability to be successful at a business that utilizes contractors should not depend on the service of independent contractors.

____ 16. Continuing relationship - Independent contractors generally do not have a continually working
relationship with an employer, typically less than year.

____ 17. Working for more than one contractor - Independent contractors who perform services usually perform those services for more than one business entity at the same time, a key test.

____ 18. Availability to the general public - Independent contractors usually make their services available to the general public on a regular or consistent basis and not tied to a non-compete.

____ 19. Discharge rights – Contracts with independent contractors cannot be terminated as long as they perform services in accordance with their contract. If a worker is subject to possible discharge, that worker is viewed as an employee.

____ 20. No compensation liability - Independent contractors may be liable for a breech of contract if they leave without completing their work. Employees may typically resign at any time without incurring any such liability.

a) Designate a point person or team to monitor independent contractor relationships. It is often helpful to have a single individual or team of people oversee the initial designation of workers as well as conduct periodic reviews because workers’ statuses may change over time. It is important that these individuals understand current laws regarding independent contractor and employee relationships and consult with in-house or outside counsel as needed. Employees in the Human Resources, Finance or Legal Departments are typically the best choices.

b) Keep basic records regarding the independent contractor determination process. The company should gather and retain key documents in support of all worker status determinations. For example, supporting documents may include business cards, tax records, work project plans and correspondence from the contractor. This documentation may serve as important evidence in the event of an audit or investigation by the DOL or a lawsuit by a worker or class of workers.

c) Use independent contractor agreements, but remember an agreement is not enough to show independent contractor status. A freely negotiated independent contractor agreement that lays out the terms of the parties’ engagement can be helpful to show that the worker is operating his own business. However, an independent contractor agreement alone is not enough to prove independent contractor status. It is important to follow the terms of the agreement and to make sure that it does not contain provisions that suggest employee status.

d) When entering into agreements with service providers, obtain appropriate indemnification to protect your company from wage and hour claims by the service provider’s workers. Employers are increasingly vulnerable to wage and hour claims by service provider’s workers. Having a clear and enforceable agreement up front that indemnifies the company from such claims will help protect it in the event these claims are later raised.

e) Don’t give independent contractors employee rights and privileges. Giving independent contractors the same rights and privileges as employees may change their status to that of an employee. For example, employers should avoid giving contractors internal email addresses and inviting them to employee functions.

f) Use the independent contractor designation sparingly. The DOL has made clear in its latest guidance that most workers will be considered employees. Therefore, careful consideration should be given to the above factors before giving a worker an independent contractor designation. Furthermore, as a practical matter, too many independent contractors relative to an employer’s workforce may alone raise a red flag.

While nothing can insulate employers completely from liability, if companies keep in mind the latest guidance from the DOL and take steps to properly classify their workers, they can greatly reduce the chances of lawsuits, penalties and fines related to worker misclassification and ensure a happier, more productive workforce.

To read the full text of the DOL’s guidance, see http://www.dol.gov/whd/workers/Misclassification/AI-2015_1.pdf