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Independent Contractors Or Employees: How Do You Classify Your Staff?

The U.S. Circuit Court of Appeals for the Tenth Circuit recently overturned a ruling concerning whether a janitorial service provider's workers were employees or independent contractors. Although the employer required the workers to form corporate entities and sign franchise agreements, the appellate court determined they were still employees under the Fair Labor Standards Act based on other factors.

In its suit against the employer, the U.S. Department of Labor had alleged that the workers were misclassified as independent contractors and that the employer failed to keep required time records.

The appellate court's ruling is in line with other decisions that determine a worker's classification as "employee" or "independent contractor" is not based on labels and business structures, but on the actual conditions of the working relationship. In this case, the court ruled that the corporate-franchisee structure was not sufficient to determine that the workers were independent contractors. Philip Bruce "Employers must still use caution when using independent contractors" employerlinc.com (Oct. 31, 2018).


Commentary

Misclassification mistakes can lead to hefty payouts and fines. In fact, federal and state fines for misclassifying staff can cost a family employer double what is owed in back pay. In order to reduce the risk of a large fine, family employers must properly determine staff classification and pay all staff their full earnings each pay period. 

According to the U.S. Department of Labor, family employers cannot use job titles alone to determine whether a worker is an independent contractor or an employee. You must satisfy both the Fair Labor Standards Act (FLSA) test for classification as well as the IRS test.

Here are the tests to discuss with your legal counsel:
 

The U.S. Department of Labor Test (FLSA compliance):

There are six factors the Department of Labor relies upon when determining whether an employer, including a family employer, and a worker have an employer-employee relationship or whether the worker is an independent contractor.

1. "The extent to which the work performed is an integral part of the employer's business." According to the DOL, work is integral if it is part of an employer's production process or a service the employer is in business to provide.

2. "Whether the worker's managerial skills affect his or her opportunity for profit and loss." For example, if a worker invests in his or her own equipment or hires his or her own employees, those decisions affect the worker's opportunity for profit and loss and tend to show an independent contractor status, rather than an employee status.

3. "The relative investments in facilities and equipment by the worker and the employer." Consider not just one such investment, but rather the totality of the investments. Look at the employer's investment when compared to the worker's. For example, a strawberry grower's investment in a hoe or a cart is minimal when compared to the employer's investment in the land and in heavy machinery.

4. "The worker's skill and initiative." Just being highly skilled does not mean a worker is an independent contractor. Skills must be used in an independent way. A highly skilled carpenter who markets his or her services, orders the materials, decides the quantities, and determines which orders to fill could be an independent contractor. By contrast, a skilled carpenter who merely provides his or her skilled labor on a project with a schedule and location directed by someone else would not be an independent contractor.

5. "The permanency of the worker's relationship with the employer."  Indefiniteness and lack of permanence suggest an employer-employee relationship.

6. "The nature and degree of the employer's control."  This factor is the one of which most employers are most aware; however, it is just one of six. What it comes down to is whether the worker is economically dependent on the employer or truly an independent businessperson.  

IRS Test:

According to the Internal Revenue Service (IRS), one who is a business owner or contractor who provides services to other businesses is a self-employed independent contractor. An independent contractor is in business for him or herself, invests in his or her own equipment and supplies, and has a broad customer base.

The IRS considers three factors when determining whether a worker is an independent contractor:

First, look at the behavior. Does the organization control or have the right to control what the worker does and how the worker does his or her job? If so, that worker is mostly likely an employee.

Second, look at the finances. Does the organization control how the worker is paid, whether expenses are reimbursed, and who provides the tools or supplies? If so, that worker is most likely an employee, and not an independent contractor.

Third, look at the relationship. Does the worker receive employment benefits like vacation pay or a pension plan? Will the relationship continue? Is the work performed an integral aspect of the business? If so, that worker is not an independent contractor.

Independent contractors are in business for themselves. They realize profit and/or loss from their effort. They invest in their business, perform services for many customers, and control what will be done and how.

For example, a worker who provides cleaning services for corporate clients, produces advertising, negotiates contracts, chooses which jobs to perform and then, hires employees to help, and recruits new clients is exercising managerial skill that affects the worker's opportunity for profit or loss. This worker is an independent contractor.


 

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