On July 15, 2015 the US Department of Labor issued some guidance on how to classify workers as employees or subcontractors. On one hand the clarification is welcomed because we often get the question “Do I need to set Tim up on payroll as an employee, or can I pay him has a subcontractor?”, and the clarification and summary we have provided below will make it easier for businesses to determine the answer. On the other hand many businesses will not like the answer going forward because the new guidance make it more difficult to classify workers as independent contractors thus requiring the need to establish payroll policies/processes and pay the associated taxes. Most of the following is taken or summarized directly from the document released by the US Dept. of Labor.
The financial risk to business
Aside from any moral or ethical obligations of properly classification workers properly and affording the rights thereof, there are financial risks to Businesses that misclassify workers. Firstly, businesses could be held liable for minimum and overtime wages. Secondly, the IRS and State Department of Labor could audit a business and find the business liable for employer taxes not paid. We are aware of instances in which the State of Tennessee has audited businesses and imposed back taxes and penalties for several years’ worth of misclassified workers.
When employers improperly classify employees as independent contractors, the employees may not receive important workplace protections such as the minimum wage, overtime compensation, unemployment insurance, and workers’ compensation. Misclassification also results in lower tax revenues for government and an uneven playing field for employers who properly classify their workers.Interpretation No. 2015-1
How to determine the proper status
In the guidance issued by the US Dept. of Labor there are 6 factors to consider when determining if a worker should be classified as an employee or an independent contractor. In undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative. The factors should be considered in totality to determine whether a worker is economically dependent on the employer, and thus an employee.
It is important to note that courts have determined that an agreement between an employer and a worker designating or labeling the worker as an independent contractor is not indicative of the economic realities of the working relationship and is not relevant to the analysis of the worker’s status. An employee is not permitted to waive employee status.
The factors should not be applied as a checklist, but rather the outcome must be determined by a qualitative rather than a quantitative analysis.
1. Is the Work an Integral Part of the Employer’s Business?
If the work performed by a worker is integral to the employer’s business, it is more likely that the worker is economically dependent on the employer. A true independent contractor’s work is unlikely to be integral to the employer’s business.
2. Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
A worker in business for him or herself faces the possibility to not only make a profit, but also to experience a loss. The worker’s managerial skill will often affect opportunity for profit or loss beyond the current job, such as by leading to additional business from other parties or by reducing the opportunity for future work. For example, a worker’s decisions to hire others, purchase materials and equipment, advertise, rent space, and manage time tables may reflect managerial skills that will affect his or her opportunity for profit or loss beyond a current job.
It is important to note that the worker’s ability to work more hours and the amount of work available from the employer have nothing to do with the worker’s managerial skill and do little to separate employees from independent contractors—both of whom are likely to earn more if they work more and if there is more work available.
3. How Does the Worker’s Relative Investment Compare to the Employer’s Investment?
The worker should make some investment (and therefore undertake at least some risk for a loss) in order for there to be an indication that he or she is an independent business. However, even if the worker has made an investment, it should not be considered in isolation; it is the relative investments that matter. An analysis of the workers’ investment, even if that investment is substantial, without comparing it to the employer’s investment is not faithful to the ultimate determination of whether the worker is truly an independent business.
4. Does the Work Performed Require Special Skill and Initiative?
A worker’s business skills, judgment, and initiative, not his or her technical skills, will aid in determining whether the worker is economically independent. The fact that workers are skilled is not itself indicative of independent contractor status. Even specialized skills do not indicate that workers are in business for themselves, especially if those skills are technical and used to perform the work.
5. Is the Relationship between the Worker and the Employer Permanent or Indefinite?
Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee. However, a lack of permanence or indefiniteness does not automatically suggest an independent contractor relationship.
6. What is the Nature and Degree of the Employer’s Control?
The worker must control meaningful aspects of the work performed such that it is possible to view the worker as a person conducting his or her own business. It is important to note with this test that it is not what the workers could have done that counts, but what the actual reality as to what the worker actually does.
The guidance recently issued by the US DOL explicitly states that “In sum, most workers are employees under the FLSA’s broad definitions.” Naturally, compliance with this guidance may create increased costs for businesses. Some businesses have never had to process a traditional payroll with all the associated filing of tax forms, issuing W-2s and submitting income tax withholding to the government. However, not complying with the new guidance could end up being more costly than complying. If you have additional questions about the proper classification or payroll processing we would love to speak with you.