In the era of the “gig economy,” where businesses hire freelancers and independent contractors (ICs) for short-term engagements, business owners may run into questions about whether workers are truly ICs, or really just part-time or even full-time employees. According to Intuit, the “gig economy” represents roughly 34% of the workforce and is expected to grow to 43% by 2020. So this isn’t just a theoretical discussion.
Employers must be aware of the multitude of organizations and rules that govern the classification and treatment of employees and independent contractors. Federal agencies like the Internal Revenue Service (IRS) and the Department of Labor (DOL), as well as individual state revenue, labor and workers compensation agencies each have different regulations regarding designation and treatment of workers.
Earlier, we covered the IRS classification criteria, and the penalties accruing to employers for misclassification of employees. Here we take a look at the DOL criteria and whether workers should be covered under laws like the Fair Labor Standards Act (FLSA), which deals with regulations regarding wages and overtime pay as well as child labor laws and what counts as “hours worked.”
Economic Realities Test
The DOL and the U.S. Supreme Court have offered a set of factors, together called the “economic realities” test, to help employers determine whether to classify a worker as an employee or an IC. Employers should consider whether the work is integral to the business. In a restaurant, for example, a chef or server is integral to the business. They are going to be an employee. However, if someone is hired to redesign the menu? That person is not integral to the business and can be an independent contractor if they pass the other parts of the test.
Business owners should look at whether the worker’s managerial skills (initiative, judgment, foresight) affect their own opportunity for profit or loss. If the worker is a credible manager of their own time and their own workers, and as a result they can make more money, they’re more likely to be an independent contractor. However, if their skills in this area have no impact on their potential for profit and loss, they’re probably an employee.
Another factor is the relative financial investment in facilities and equipment. If the employer has purchased the necessary tools to get the job done, such as a laptop and specific software, it is more likely the worker is an employee. Conversely, if the worker has purchased those items or they are paying office rent, or their own professional dues or licensure, they more likely an IC.
Also considered is the skills and initiative used elsewhere. Can the worker sell their services in the open market? If the employer has tried to lock them down so they cannot offer their services to the competition, then an employee relationship likely exists.
What is the permanency of the relationship? If an individual is hired in an open-ended agreement, they’re probably an employee. ICs generally are hired for a certain amount of time or for a specific project.
Finally, a big consideration is the nature and degree of control exerted by the hirer over the worker. Are they told where to do the job, when to do the job, and most importantly, how to do the job? If the answer to these questions is “yes,” they are probably an employee.
Note that these rules apply to temporary workers, to workers who don’t “work out” and those who “ask” to be treated as an IC.
Other Benefits May Be Owed to Misclassified Employees
In addition to the fines, back payments and other penalties outlined here, a misclassified employee who files a complaint with the DOL or their state labor agency may be eligible for benefits owed to them, including:
- 401(k) contributions
- Health and welfare coverage
- Paid time off
- Break time
- Stock Options
Audits and lawsuits arising from misclassification can cripple a company. In addition to legal fees, punitive damages, back payments and lost employee time, a lawsuit can cost an organization its reputation.
Given what’s on the line, it is worth making sure workers are classified correctly. Our HR Pros can help you determine the correct worker classifications. For more information on HR Support Center, click here.