Independent Contractors: Proper Classification is a Must

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From WilsonHCG, Rosimar Lehr reviews the standards for the IRS and US Department of Labor for classifying workers as employees or independent contractors. Rosimar writes:

THE ECONOMIC REALITIES TEST – SIX FACTORS (DOL)

The Economic Realities Test is a test that examines six factors, five of which were identified by the US Supreme Court. This test is used by the DOL to properly classify workers. The Economic Realities Test was formally interpreted by the Administrator, David Weil, in the Administrator Interpretation No. 2015-1 on July 15, 2015, in an effort to decrease misclassification by employers.

The Federal Labor Standards Act defines “employ” to include “to suffer or permit to work.” This means if the employer requires or allows employees to work, the time spent is generally hours worked. The question remains whether the worker is in business for him- or herself or working for the employer. What are the factors for his or her actions? Let’s take a look at the six factors used by the DOL:

  • Is the work performed an integral part of the employer’s business? An integral part of the employer’s business can be defined by whether the work performed is an essential constituent of the whole. For example, for the worker if the answer is yes, it is more likely the worker is economically dependent on the employer.
  • Do the worker’s managerial skills affect his or her opportunity for profit or loss? The worker’s ability to work more hours, hire others, market or advertise and manage time schedules will affect his or her opportunity for profit or loss, not the amount of work available from the employer.
  • How much has the worker invested in his or her job compared to the employer? If the worker has purchased his or her own materials for work, own automobile and or advertising, this is indicative of an IC.
  • Does the work require initiative and business skills? A worker who determines the type of materials for the work, the timing for ordering the materials or what will get done demonstrate the initiative of an IC.
  • How long is the work for? This is not dispositive but may be suggestive of an employee relationship if the worker is only working for one employer and has done so for years.
  • Does the employer exercise control over the worker? Can the worker change the schedule, or negotiate his or her pay?

All six factors used by the DOL should be examined by the employer for compliance. Written agreements labeling the work relationship is a good practice but cannot be relied upon for classification. The Administrator’s Interpretation 2015-1 suggests the DOL’s focus is on the worker’s economic independence and not solely on control by the employer.

THE CONTROL TEST – THREE CATEGORIES (IRS)

The historic IRS standard for classifying the worker for federal tax purposes was a 20-Factor Test but recently, the IRS has grouped those 20 factors into three categories.

  • Behavioral Control: The worker may be examined by what type of instructions he or she is given on how the work is to be accomplished, the degree of the instructions, how the work is evaluated and if training is needed or given. An employment relationship may be found where an employer controls what tools are used, when and where work will be done, how the work will be performed and/or where the supplies and/or services will be bought. An independent contractor will schedule their work, not require many instructions on how the work is to be done, and will be skilled with little if any training required.
  • Financial Control: Are key financial aspects of the worker’s work controlled by the employer or client? Does the worker pay for their own tools, operations costs, training, and/or other unreimbursed business expenses? Are the wages negotiable, is the worker supplied with a company card for materials, or is the worker given a vehicle?
  • Type of Relationship: Does the worker have a contract with the employer? Does the worker receive benefits such as insurance or paid vacation? Is the worker hired for a specific period of time? Look for a dependency on the employer or independent relationship based on the relationship.

The IRS also offers a determination of worker status for an employer who is unsure and needs assistance. The form to submit is a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding found on the IRS website. Once this form has been completed and sent to the IRS, the IRS will review it and submit a Determination Ruling Letter.

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