by Laura Pokrzywa
According to the Internal Revenue Service (IRS), an independent contractor is generally defined as someone whose payer has “the right to control or direct only the result of the work and not what will be done and how it will be done.” In other words, someone who performs services that can be controlled by an employer (what will be done and how it will be done) is NOT an independent contractor.
Though that definition seems clear enough on the surface, if you are the one responsible for deciding who gets a 1099 and who gets a W-2, you know that definition leaves many questions unanswered. In fact, the IRS estimates that the number of employees who have been misclassified as independent contractors is in the millions. Does it really matter, as long as the worker is getting paid?
In an attempt to clarify this broad definition, the Wage and Hour Division of the Department of Labor (DOL) issued an Administrative Interpretation earlier this month. The Interpretation is not a change in policy or law. It simply provides new guidance for employers. In this new guidance, the DOL reminds employers that when employees are improperly classified as independent contractors, the employees may not receive important workplace protections such as the minimum wage, overtime compensation, unemployment insurance, and workers’ compensation.
ECRM’s Renee Mielnicki, Esq. addressed this issue in her December 2013 blog post. She warns that misclassifying employees will also cost the employer. “The tax and employee benefit savings may make it appealing for an employer to misclassify an employee as an independent contractor. However, as scrutiny continues to rise, so do the consequences. Currently, if you are audited by the IRS and found to have misclassified an employee, you will be forced to pay back taxes, with interest, and a penalty.”
The DOL’s 15-page Interpretation of the Fair Labor Standard Act’s (FLSA) uses an “economic realities” test to determine if an employee can rightfully be classified as an independent contractor. “Ultimately, the goal is . . . to determine whether the worker is economically dependent on the employer (and thus its employee) or is really in business for him or herself (and thus its independent contractor).”
Creative labels are not the answer either. It does not matter what you call the worker (“independent contractor”, “subcontractor”, “member of a limited liability company”, “partner”, etc.). If they fit the definition of “employee”, that is what the courts and the DOL will consider them to be.
The DOL’s guidance refers employers to the multi-factor “economic realities” test developed by the Supreme Court and Circuit Courts of Appeals to determine whether a worker is an employee or an independent contractor under the FLSA. Please note that the Interpretation warns these factors should not be applied as a checklist. Instead, they must all be considered in total, as they relate to each other. No one factor should be over-emphasized.
The factors typically include:
A. the extent to which the work performed is an integral part of the employer’s business;
B. the worker’s opportunity for profit or loss depending on his or her managerial skill;
C. the extent of the relative investments of the employer and the worker;
D. whether the work performed requires special skills and initiative;
E. the permanency of the relationship; and
F. the degree of control exercised or retained by the employer.
If you would like more details about any of these factors, you will find clear examples of actual cases for each of these factors in the DOL’s Administrative Interpretation.
If you have questions about any HR issues, please send us an email at email@example.com and we will be happy to help.
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