Imagine working as a dog groomer grooming dogs as an employee one day, but the next day, while performing the same work on the same puppy for the same company, you’re told you are now considered an independent contractor. You didn’t suddenly open a business of your own. Nothing about your work changed. But now, you’re told that since you’re no longer an employee, you’re no longer eligible for overtime pay, unemployment insurance, worker’s compensation or a host of other benefits that come with employee status.
That really happened to a client recently, who we discovered was owed back wages after conducting an investigation. Unfortunately, this situation is all too common − with terrible consequences. Misclassified employees are often denied access to the critical benefits and protections they are entitled. Misclassification also generates substantial losses to the federal government and state governments in the form of lower tax revenues, as well as to state unemployment insurance and workers’ compensation funds. It forces workers to pay the entirety of their payroll (FICA) tax. It also tips the scales against all of the employers who play by the rules and undermines the economy.
What is the Worker Classification Relationship?
Whether a worker is an employee under the Fair Labor Standards Act (FLSA) is a legal question determined by the economic realities of the working relationship between the employer and the worker, not by job title or any agreement that the parties may make. The Labor Department supports the use of legitimate independent contractors − who play an important role in our economy − but when employers deliberately misclassify employees in an attempt to cut costs, everyone loses.
In order to make the determination whether a worker is an employee or an independent contractor under the FLSA, courts use the multi-factorial “economic realities” test, which focuses on whether the worker is economically dependent on the employer or in business for him or herself:
- Is the work performed by the individual an “integral part of the employer’s business?” If workers perform services that the company is in the business of providing (workers answering phones at a call center is one example provided in the memorandum), they are more likely to be considered employees.
- Does the individual’s “managerial skill” affect his or her opportunity for profit or loss? A worker, who has the opportunity to hire others or purchase equipment and materials in order to increase profit, is more likely to be considered independent. A worker’s ability to simply work more hours to increase compensation, by contrast, does not reflect managerial skill and does not distinguish a worker as an independent contractor.
- How does the worker’s investment compare to that of the company? Workers should make some significant investments in the business in order to be considered an independent contractor in business for him or herself.
- 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.”
- Is the relationship between the worker and the company permanent or indefinite? A long-term relationship between the parties suggests the worker is an employee. According to the DOL, a worker truly in business for him or herself, “typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer.”
- 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.” The DOL emphasizes that “the ‘control’ factor should not play an outsized role in the analysis of whether a worker is an employee or an independent contractor… the FLSA covers workers of an employer even if the employer does not exercise the requisite control over the workers, assuming the workers are economically dependent on the employer.” (Emphasis added.)
What are some Examples of an Employee vs Independent Contractor?
Building and Construction Industry Example – Jerry Jones has an agreement with Jessica Simpson to supervise the remodeling of her house. She did not advance funds to help him carry on the work. She makes direct payments to the suppliers for all necessary materials. She carries liability and workers’ compensation insurance covering Jerry and others that he engaged to assist him. She pays them an hourly rate and exercises almost constant supervision over the work. Jerry is not free to transfer his assistants to other jobs. He may not work on other jobs while working for Jessica. He assumes no responsibility to complete the work and will incur no contractual liability if he fails to do so. He and his assistants perform personal services for hourly wages. Jerry Jones and his assistants are employees of Jessica Simpson.
Trucking Industry Example – Dallas Trucking contracts to deliver material for Josey, Inc., at $140 per ton. Dallas Trucking is not paid for any articles that are not delivered. At times, Tess Dallas, who operates as Dallas Trucking, may also lease another truck and engage a driver to complete the contract. All operating expenses, including insurance coverage, are paid by Tess Dallas. All equipment is owned or rented by Tess and she is responsible for all maintenance. None of the drivers are provided by Josey, Inc. Tess Dallas, operating as Dallas Trucking, is an independent contractor.
Computer Industry Example – Zack Martin, a computer programmer, is laid off when Megabyte, Inc., downsizes. Megabyte agrees to pay Zack a flat amount to complete a one-time project to create a certain product. It is not clear how long that it will take to complete the project, and Zack is not guaranteed any minimum payment for the hours spent on the program. Megabyte provides Zack with no instructions beyond the specifications for the product itself. Zack and Megabyte have a written contract, which provides that Zack is considered to be an independent contractor, is required to pay federal and state taxes, and receives no benefits from Megabyte. Megabyte will file Form 1099-MISC, Miscellaneous Income, to report the amount paid to Zack. Zack works at home and is not expected or allowed to attend meetings of the software development group. Zack is an independent contractor.
Automobile Industry Example – DeMarca Lawrence is a salesperson employed on a full-time basis by Cory White, an auto dealer. She works six days a week and is on duty in Cory’s showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager’s approval. Lists of prospective customers belong to the dealer. She is required to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Cory. Cory also pays the cost of health insurance and group-term life insurance for DeMarca. DeMarca is an employee of Cory White.
Attorney Example – Tracy Williams is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research linkup, fax machine, and photocopier. Tracy buys office supplies and pays bar dues and membership dues for three other professional organizations. Tracy has a part-time receptionist who also does the bookkeeping. She pays the receptionist, withholds and pays federal and state employment taxes, and files a Form W-2 each year. For the past 2 years, Tracy has had only three clients, corporations with which there have been long-standing relationships. Tracy charges the corporations an hourly rate for her services, sending monthly bills detailing the work performed for the prior month. The bills include charges for long distance calls, on-line research time, fax charges, photocopies, postage, and travel, costs for which the corporations have agreed to reimburse her. Tracy is an independent contractor.
Taxicab Driver Example – Jason Witten rents a cab from Taft Cab Co. for $150 per day. He pays the costs of maintaining and operating the cab. Jason Witten keeps all fares that he receives from customers. Although he receives the benefit of Cowboy’s two-way radio communication equipment, dispatcher, and advertising, these items benefit both Cowboy and Jason Witten. Jason Witten is an independent contractor.
Salesperson Example – To determine whether salespersons are employees under the usual common-law rules, you must evaluate each individual case. If a salesperson who works for you does not meet the tests for a common-law employee, discussed earlier in this section, you do not have to withhold federal income tax from his or her pay
However, even if a salesperson is not an employee under the usual common-law rules for income tax withholding, his or her pay may still be subject to social security, Medicare, and FUTA taxes as a statutory employee. To determine whether a salesperson is an employee for social security, Medicare, and FUTA tax purposes, the salesperson must meet all eight elements of the statutory employee test. A salesperson is a statutory employee for social security, Medicare, and FUTA tax purposes if he or she: 1. Works full time for one person or company except, possibly, for sideline sales activities on behalf of some other person, 2. Sells on behalf of, and turns his or her orders over to, the person or company for which he or she works, 3. Sells to wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments, 4. Sells merchandise for resale, or supplies for use in the customer’s business, 5. Agrees to do substantially all of this work personally, 6. Has no substantial investment in the facilities used to do the work, other than in facilities for transportation, 7. Maintains a continuing relationship with the person or company for which he or she works, and 8. Is not an employee under common-law rules.
Where can an Employer get help with Classification?
The Voluntary Classification Settlement Program (VCSP) is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply. Specifically, a taxpayer must be treating the workers to be reclassified as independent contractors or other nonemployees; additionally, the taxpayer must have consistently treated the workers as nonemployees, including having filed any required Forms 1099, consistent with the nonemployee treatment, for the previous three years with respect to the workers to be reclassified.
A taxpayer participating in the VCSP will agree to prospectively treat the class or classes of workers as employees for future tax periods. In exchange, the taxpayer will:
- Pay 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509(a) of the Internal Revenue Code.
- Not be liable for any interest and penalties on the amount; and
- Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.
The U.S. Department of Labor’s Wage and Hour Division (WHD) is responsible for administering and enforcing some of the nation’s most important worker protection laws. WHD is committed to ensuring that workers in this country are paid properly and for all the hours they work, regardless of immigration status. If you have questions or concerns, you can contact WHD at 1-866-487-9243 or visit www.wagehour.dol.gov.
The information below is useful to file a complaint with WHD:
- Your name
- Your address and phone number (how you can be contacted)
- The name of the company
- where you work(ed)
- Location of the company (this may be different from where you worked)
- Phone number of the company
- Manager’s or owner’s name (who should we ask to speak to)
- Type of work you did
- How and when you were paid (i.e. cash or check, every Friday)
Any additional information that you can provide such as copies of pay stubs, personal records of hours worked, or other information on your employer’s pay practices are helpful. All services are free and confidential, whether you are documented or not. Please remember that your employer cannot terminate you or in any other manner discriminate against you for filing a complaint with WHD.