What is the issue?
Many employers treat their employees as independent contractors in an attempt to reduce their tax burdens. This misclassification has caught the attention of state governments and court systems across the nation. Illinois and New York have enacted strict laws imposing penalties on employers misclassifying their employees as independent contractors. Both states have task forces that are responsible for uncovering any misclassification in the construction industry.
Federal courts use an “economic realities” test to determine whether someone is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). Depending on the state, they may also use framework provided by the IRS to determine the hired individual’s status. IRS Publication 1779 looks at three categories to answer the crucial question: Behavioral control, Financial control, and the Relationship of the Parties.
1. Behavioral Control
This category of the IRS Publication 1779 focuses on how the work was performed and the level of supervision. Some other questions to consider when identifying your employee or independent contractor are:
- Who has the right to supervise the work?
- Employees are highly supervised, while independent contractors are rarely supervised.
- Who provides the equipment or the supplies needed for the job?
- An employee is provided with the tools necessary for the job, while the independent contractor brings his own supplies.
- Can the individual hire helpers or “subcontract” the work?
- An independent contractor is usually able to hire helpers.
- Who controls the timing of when the work is completed?
- Employers strictly control timing for their employees, but not for their independent contractors.
- Are training or company procedures required to perform the work?
- Independent contractors should not need any training to perform their job, while employers are expected to provide their employees with training. Employees should also be aware of company policies and procedures.
2. Financial Control
This second category focuses on the financial control within the relationship. It looks at how financially invested an individual is in the job. Here are some questions to consider:
- Is the individual significantly invested in his/her work or are they just working for a paycheck?
- Independent contractors are generally more invested in their work than employees, who only work for a paycheck.
- Is the individual reimbursed by the employer for business expenses?
- Employees are typically reimbursed, while independent contractors see business expenses as business costs.
- Does the individual have an opportunity for profit or loss based on quality and/or quantity of the work?
- The quality and quantity of the work done by independent contractors usually determines their profits or losses, but the same cannot be said for employees.
3. Relationship of the Parties
The last category of the IRS Publication 1779 focuses on the relationship between the individual and the employer. Some questions to consider when identifying the individual you are hiring are:
- Is there a written contract between the individual and the company?
- Independent contractors should have a written contract with the company.
- Does the individual receive any benefits from the company?
- Employees may receive benefits from the company, but the independent contractor only receives the consideration set forth in the written contract.
Although many states do not have strict laws enacted against misclassification, we recommend employers carefully consider whether they have hired an employee or an independent contractor. The financial ramifications of misclassification are significant. Not only can employers be held liable for unpaid minimum wages and overtime pay, they may also have to pay the employer’s portion of FICA contributions. We recommend using the IRS framework provided above to carefully consider whether you have hired an independent contractor or an employee to avoid financial penalties in the future.
Source referenced: JD Supra