Employee vs. Independent Contractor: Can You Tell the Difference?

State and federal regulators are increasingly acting to combat worker misclassification.

Before using independent contractors, it is imperative to verify that they are not actually employees. The issue is legal in nature so the legal principals must be thoroughly considered and applied. Mistakes, no matter how innocent, can result in costly lawsuits and significant legal penalties.

Worker misclassification occurs when a bona fide, common law employee is classified to be an “independent contractor.” In some cases, worker misclassification is intentional to avoid tax withholding, overtime pay and insurance requirements such as Workers Compensation and Unemployment Insurance. Sometimes it occurs simply because the employer did not properly understand the law.

To aid the analysis, the Department of Labor (DOL) recently published a revised factsheet on worker misclassification. As the DOL highlights, an employment agreement stating that a worker is an independent contractor hold very little weight, if any. Rather, the actual nature of the working relationship is determinative. Over 25 states also apply the “ABC” test which is even more difficult to overcome (as many prominent trucking companies have been learning in recent court cases).

Below are several key factors that are generally considered when determining whether an employment relationship exists:

• The extent to which the work performed is 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 and less likely that the worker is in business for himself or herself.
• The permanency of the worker’s relationship with the employer. Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee
• The worker’s skill and initiative. The exercise of independent business judgment and the fact that a worker is in open market competition with others would suggest independent contractor status.
• The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment (and bear some risk for a loss) in order for there to be an indication that he/she is an independent contractor in business for himself or herself.
• The nature and degree of control by the employer. This complex factor requires analysis of who sets pay amounts and work hours and who determines how the work is performed. An independent contractor is generally free to work for others and hire helpers and perform tasks under minimal control by the employer.

When an employer-employee relationship exists, workers must be compensated in accordance with myriad employment laws to include the Fair Labor Standards Act (FLSA), which covers minimum wage, overtime, and recordkeeping requirements. The failure to include employees as participants in employee benefit plans (pension and health) can expose the employer and its officers, directors and shareholders to significant personal liability under the Employee Retirement Income Security Act (ERISA).