Independent Contractor or Employee: What’s the Current Test?

With a labor shortage and COVID-19-related budget crunches, some nonprofits have turned to freelancers and contractors to fill staffing gaps. But are those individuals actually employees? Employers that misclassify workers can face harsh consequences, so it’s important to know the proper standard. Now is a good time for nonprofits to review the test that has long applied.

Role of economic realities

The Fair Labor Standards Act (FLSA) doesn’t define the term “independent contractor.” Courts, however, generally have focused on several factors related to the “economic reality” of relationships between employers and workers.

A Trump administration rule would have also emphasized economic realities, with a focus on the nature and degree of a worker’s control over the work and the worker’s opportunity for profit or loss based on his or her initiative and investment. But that rule, scheduled to take effect on March 8, 2021, was withdrawn by the U.S. Department of Labor (DOL) under the Biden administration.

Supreme Court’s 7 factors

The DOL will continue to lean on U.S. Supreme Court rulings for guidance. The Court has repeatedly stated that no single rule or test applies to determine employment status under the FLSA. Rather, the totality of circumstances determines a worker’s status, including the:

  1. Extent to which the services rendered are an integral part of the employer’s business,
  2. Permanency of the relationship,
  3. Amount of the alleged contractor’s investment in facilities and equipment,
  4. Nature and degree of control by the employer,
  5. Alleged contractor’s opportunities for profit and loss,
  6. Amount of initiative, judgment or foresight in open market competition with others required for the success of the claimed independent contractor, and
  7. Degree of independent business organization and operation.

The Supreme Court also has held that the time or mode of pay isn’t determinative.

The DOL has identified other factors it deems relevant, including where the work is performed (remotely or on-site), the absence of a formal written employment contract (or the existence of an “independent contractor agreement”), and whether the work is licensed by the state or local government. Providing workers with IRS Form 1099, “Miscellaneous Information” instead of Form W-2, “Wage and Tax Statement,” also won’t make them independent contractors.

Keep in mind that some states have even more restrictive tests. Moreover, the fact that workers qualify as independent contractors under another federal law doesn’t guarantee they qualify under the FLSA. The IRS, for example, applies a different test. (See “The IRS approach to worker classification.”)

Why it matters

When workers don’t qualify as independent contractors, under the FLSA, you generally must pay covered, nonexempt employees at least the federal minimum wage of $7.25 an hour. When an employee’s hours within a workweek exceed 40, you must pay at least 1½ times the employee’s regular pay rate.

Failure to properly determine worker status can prove costly. In addition to having to make up the unpaid wages and employment taxes for individuals reclassified as employees, you can end up on the hook for workers’ compensation premiums, unpaid leave and other benefits. Fines and penalties are possible, as well. The Obama administration launched a DOL “Misclassification Initiative” to crack down on employers that mislabeled their workers. The Biden administration might pursue a similar enforcement program.

Don’t take the risk

Misclassification of employees as independent contractors may produce short-term benefits. But you’ll only increase your potential liability in the long run. We can help your organization ensure it’s in compliance with the FLSA and other applicable standards.

The IRS approach to worker classification

The IRS traditionally has applied a 20-factor test to determine if a worker is an employee. The factors generally consider three areas related to the employer’s right to control the work:

Behavioral control. To what extent do instructions, training and evaluations demonstrate that you have a right to control how the worker performs the work — regardless of whether you actually exercise the right? Thus, workers who require your approval before taking certain actions probably are employees.

Financial control. Do you have a right to control the economic aspects of the work? For example, does the worker incur significant unreimbursed expenses or is the worker available to work for other companies? Both circumstances suggest the person is an independent contractor.

The parties’ relationship. How do the parties regard their relationship? For example, if you provide employee benefits, it might show you intend the worker to be an employee. Conversely, a short-term relationship could indicate a contractor relationship.

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