News & Insight

What's in a Name? Independent Contractors v. Employees

Classifying or misclassifying someone as an employee or an independent contractor can have significant effects for employers.

In an examination of the use of titles, Shakespeare famously wrote “That which we call a rose, by any other name would smell as sweet.”  Shakespeare clearly did not consider employment law when he wrote that metaphor because the name by which workers are called has serious legal implications for employers.

The financial ramifications of misclassifying employees as independent contractors can be costly.  As a graphic  illustration, the Department of Labor recently obtained a consent judgment to recover $1.3 million in back wages for more than 14,500 workers whom  kgb USA Inc. mistakenly classified as independent contractors and  failed to pay at least the  minimum wage.  Microsoft and other large companies have had similar experiences and attorneys representing employees are always trolling for wage and hour cases to file against unsuspecting employers.  So, what’s in a name can be very important.

Although it can be difficult to define, what makes an independent contractor is outlined by common law principles, IRS rules, the Fair Labor Standards Act (FLSA) and by numerous court decisions. 

The IRS uses a “20 Factor Test” to classify workers as employees or independent contractors, but  an individual need not meet all of those criteria in order to be properly categorized as one or the other  The non-comprehensive list below summarizes the 20 Factor Test into three primary categories. 

Level of control:

As the degree of a company’s control over how, when, where, and by whom work is performed increases the likelihood that workers should be classified as employees, not independent contractors.  For example, the requirement that an individual participate in company training and perform services in compliance with company-mandated rules, procedures, and schedules usually denote an employment relationship since the company is directing the method of work.  Similarly, a company’s right to insist that work be done by a particular person or in a particular sequence indicates that an employment relationship exists because independent contractors are usually free to assign the work to others as they see fit.  The same relationship may be created if the company specifies the business hours, location, and number of hours to be worked

Nature of the work relationship:

A continuous relationship over a number of years indicates an employment relationship unless there are at least occasionally significant breaks during that period   In case that gained much notoriety, Microsoft was hit with millions of dollars in liability for overtime and employee benefits owed to individuals who had been mistakenly classified as independent contractors while they performed services for a continuous period of several years.     

Workers whose services are significantly integrated into the business operations must typically be classified as employees.   For example, IT personnel who spend all of their work time servicing one company’s computer system should probably be treated as employees, not independent contractors.  By way of comparison, an individual who only sporadically repairs that system and also provides similar services for other companies is much more likely to be treated as an independent contractor.    

Compensation and investment:

Weekly or monthly pay at set rates in accordance with a payroll system, rather than in response to periodic invoices submitted by a worker, is characteristic of an employment relationship. Workers who perform most of their work using company-provided equipment, tools, supplies, or materials are usually considered employees 

Independent contractors normally invest in their own facilities, equipment, and offices.  Personal investment, with concomitant the possibility of realizing significant profit or loss through operations, usually indicates independent contractor status.  The fact that an individual carries its own liability and worker’s compensation insurance is an additional indicator of that status. 

Still not sure?

Employers who are uncertain about how to classify a worker can request an IRS determination by filing a Form SS-8, “Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding.”   We want to point out, however, that the IRS will err on the side of classifying workers as employees and may take several months to issue a determination.   In the meantime, the employer is left to guess how to treat a worker. 

Employers can obtain more objective and expedient advice by consulting an attorney experienced in tax or employment law.  .   If you want to consult with such an attorney, you may contact Bowie & Jensen, LLC.