EMPLOYEE OR INDEPENDENT CONTRACTOR?

Municipal Attorney’s Conference

August 4, 2007

How Can You Tell the Difference Between and Employee and an Independent Contractor?

The essence of the relationship between an employer and an independent contractor is the agreement by the independent contractor to do certain work according to his or her own judgment and methods, without being subject to oversight by the employer except as to the results of the work.

  • Another way of saying this is that an independent contractor is an individual performing services for the employer who is subject to the control and direction of the employer only with respect to the result sought, and not as to the means and methods of accomplishing the task.

An employer, on the other hand, not only gives the employee assignments, but may require the employee to perform his or her duties in particular ways using particular methods and at particular times. An employee may be disciplined and/or discharged for failure to follow the employer’s instructions about how to perform a task.

  • It is not necessary that the employer actually direct or control the manner in which the worker performs duties and assignments — it is enough that the employer has the right to do so.

To determine whether or not a worker is an employee for FLSA purposes, courts have developed what is called an “economic reality” test. The economic reality test looks at whether a worker is economically dependent upon the organization to which he or she renders services. To put it another way, the courts ask whether a worker depends upon an “employer” for the opportunity to render service or whether the worker is in business for himself or herself. To make this determination, the courts use a six-factor test that asks:

  • What is the nature and degree of control that the employer has over the way in which the worker is to perform the work?
  • Does the worker have an opportunity to make a profit or a loss?
  • Does the worker have an investment in the materials, equipment or other personnel required to perform the work?
  • Does the work require skill and independent initiative?
  • What is the expected duration of the working relationship?
  • To what extent is the work an integral part of the employer’s operations?

The IRS uses a similar test. In Revenue Ruling 87-41, it listed twenty factor that the courts considered in applying the common law right-to-control test. This list has come to be known as the IRS’ Twenty Factor Test:

  1. Must the worker comply with another person’s instructions about the work?
  2. Does the worker require training to do the work?
  3. Is the work performed by the worker integrated into the hiring organization’s operations?
  4. Must the worker perform the services personally?
  5. Who hires, supervises and pay’s the worker’s assistants, if any?
  6. Do the worker and the hiring organization have a continuing relationship?
  7. Must the work be performed during set hours?
  8. Must the worker devote most of his/her time to work for the hiring organization?
  9. Must the work be performed on the hiring organization’s premises or can it be done elsewhere?
  10. Must the worker perform the work in an order or sequence set by the hiring organization?
  11. Must a worker submit reports?
  12. Is the worker paid by the hour, week or month?
  13. Are the worker’s business or traveling expenses paid by the hiring organization?
  14. Does the worker furnish the tools, material and equipment needed to perform the work?
  15. Does the worker have a significant investment in the facilities needed to do the work?
  16. Can the worker make a profit or suffer a loss as a result of performing the services

for the hiring organization?

  1. Can the worker work for more than one hiring organization or person at one time?
  2. Does the worker make his/her services available to the general public?
  3. Can the hiring organization discharge the worker?
  4. Does the worker have the right to terminate the relationship with the hiring organization?

Diane’s Gloss on the Right-to-Control Test:

  1. Must the worker comply with instructions? If the employer can tell the worker
  • when and where to do the work;
  • what tools or equipment to use to do the work;
  • which workers or assistants to hire or use;
  • where to purchase supplies or services;
  • what work must be performed by a specific individual; or
  • what order or sequence to follow

then the employer has retained the right to control the worker’s performance, and the worker is an employee. An independent contractor cannot be told when, where or how to do the job.

  1. Must the worker be trained by the employer? Independent contractors typically do not go through any type of instructional or training period with a more experienced employee to learn how to do the job.
  1. What degree of skill, initiative or judgment is required to perform the work? Less is usually typical of employees; more of independent contractors.
  1. Where is the work performed? An independent contractor usually works off-premises, unless the nature of the work requires his or her presence on the employer’s premises.

Degree of Financial Control:

  1. Does the worker have the opportunity to make a profit or a loss? An independent contractor typically has the ability to make a profit or a loss, while an employee does not. Ability to make a profit or suffer a loss is among the strongest evidence that the worker controls the business aspects of the services rendered and is an independent contractor.
  1. Does the worker have an investment in the facilities where the services are performed or the equipment s/he uses to perform services? An employee typically uses the employer’s facilities, equipment and material.
  1. Does the worker have unreimbursed business expenses associated with the services s/he performs? Unreimbursed expenses are more typical of independent contractors than of employees.

Nature of the Relationship:

  1. Is there a continuing relationship? The relationship between an independent contractor and an employer ends when the job is done. If employer and worker expect the relationship to continue indefinitely, this is considered evidence that the relationship is one of employer-employee.
  1. To what extent do the services performed by the worker play a key role in the regular operations of the employer? If the success or continuation of the employer’s operations in a given area depends on the services that the worker provides, then it is more likely than not that the employer will have the right to direct the worker’s activities, and that the worker is an employee.
  1. Does the worker receive pension, health or life insurance benefits, or vacation or sick leave? Employees generally participate in such plans; independent contractors do not.
  1. How does the employer pay the worker? An employee is typically promised a regular wage or salary for an hour, day, week, month or other period of time. An independent contractor is usually paid a flat fee for a job
  • Note that it is customary to pay independent contractors in certain professions an hourly fee — an attorney on retainer to a local government or government agency may be paid on an hourly basis without becoming an employee. This is a limited exception, however.

12. Does the worker offer services to the general public? Typically, an independent contractor can work for more than one client at a time.

13. Does the worker offer services through a corporation? Even if the worker is the sole owner of the corporation, s/he will generally be considered an employee of the corporation, rather than of the public employer, for federal tax and wage and hour purposes.

  • The worker must keep up with corporate formalities and be able to show that the corporation exists for at least one other purpose than evading wage and hour and tax laws with respect to this one employer.

14. How is payment made? An independent contractor is generally paid in a lump sum fee basis when the job is done.

15.Can the worker be discharged? An independent contractor cannot be terminated as long as he or she is fulfilling the terms of the contract.

16.Can the employer refuse to pay the worker for services rendered? An employer may generally refuse to pay an independent contractor for unsatisfactory work or unsatisfactory results regardless of the number of hours that the worker has spent on the project. An employer must pay an employee for time spent on the job, regardless of how unproductive the employee has been or unsatisfactory the results of the employee’s efforts.

  1. Is there a written contract? How does the contract characterize the relationship?
  • Note that merely calling a worker an “independent contractor” in a written contract is not sufficient to escape liability for misclassification under the Internal Revenue Code or the FLSA if all the other evidence suggests that the worker’s legal status is that of employee.

None of the answers to these questions are dispositive on the question of whether a worker is an employee or an independent contractor, but all are important in helping determine the extent to which the employer retains the right to control the worker. The weight given to each factor will be different depending on the occupation involved and the particular circumstances in which the services are provided.

When in doubt:

  • Classify the worker as an employee (this is what the IRS and DOL will do).

or

  • Submit IRS Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding

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