When is a Worker an Employee or a Contractor?
Introduction
Some employers resist correctly classifying their workers. Their motive for misclassifying workers is usually a function of short-term thinking (e.g. saving money now). Sometimes this misclassification happens because of ignorance or bad advice.
A common misunderstanding is that if a worker is paid less than $600 by a business during a calendar year for work performed for that business, that worker is automatically a contractor and no paperwork (e.g. 1099-NEC, 1099-MISC, W-2, etc.) needs to be done. This is incorrect. A business (and its owners and managers) can experience serious, negative adverse (criminal, civil, and financial) consequences when misconduct involving misclassification of workers as contractors is determined by a regulator.
Unfortunately, the tendency is for those employers to classify their workers as contractors until those employers are caught by one or more national regulators (e.g. Internal Revenue Service, Occupational Safety and Health Administration, US Department of Labor, National Labor Board, etc.) or state and local regulators. Even when employers misclassify their workers as contractors (vs. employees), these employers remain liable for the employer’s taxes, unpaid statutory required benefits, and insurance costs associated with these misclassified employees.
A regulator can impose fines on these employers and, often, will share their determinations with other regulators. Other regulators can then impose their own fines on the offending employer. These same employers can experience both criminal and civil prosecutions over their misclassifications. Employers should be aware that their potential costs to navigate such a legal situation can include attorneys’ fees (including the other side’s costs) and punitive damages. The end result will almost always result in these employers spending far more to settle the issues raised by the regulators than it would have cost them to have complied with the law and classified their workers appropriately from the very beginning.
Criteria Used to Classify Workers
It is important to realize that there is no “silver bullet” or single factor that an employer can use to determine how to classify their workers. The courts will weigh several factors to determine if a worker is properly classified. If an employer has any doubt as to their ability to have their classification decision upheld in court, that employer should classify a worker as an employee instead of a contractor. The primary factors that a court will examine before making any conclusions are outlined below 1, 2, 3.
- Behavioral Control (Instructions/Directions/Training) - The more the following conditions exist, the more likely the worker is an employee and not a contractor.
- Can the business control variables such as when the work is done, where it is done, or how it is done?
- Employers have the right to mandate where the work is done, but do not have to exercise this right.
- Employers have the right to determine when the work is done, but do not have to exercise this right.
- Employers have the right to determine the quality of the work being done or the specific procedures or methods used when the work is performed, but do not have to exercise this right.
- Can the business provide tools, software, or equipment for use when the work is performed?
In certain situations, employers may require their employees to purchase hand tools (a common practice in the construction and mechanical fields). This is usually driven by an employer’s desire to control losses associated with small tools that are at high risk of being lost or stolen.
- Can the business control the hiring process over who assists in the performance of the work?
Employers have the right to decide who will assist in the performance of the work and have the right to exercise control over the hiring process but do not have to exercise these rights. Employees do not have such control.
- Can the employer control the process of purchasing supplies and services necessary to perform the work?
Employers have the right to exercise control over the acquisition process of supplies and services necessary to perform the work. Employees do not have such control.
- Can the employer provide instructions, training, or education on how to do the work in a specific manner or comply with regulations and laws associated with that business?
- Can the business control variables such as when the work is done, where it is done, or how it is done?
- Financial Control - The more the answers to these questions is “the business” the more likely it is that the worker is an employee and not a contractor.
- Who controls the business part of the work?
An employer makes a significant investment in resources to use with that business activity. While no bright-line test exists, that employer has the risks associated with making a profit or incurring a loss from the business activity. Employees do not have such risks as all they are providing is their labor.
- Who is responsible for the expenses incurred during the course of conducting a business activity?
- Employers are responsible for the expenses incurred to run the daily operations of a business activity.
- Employees are normally only responsible for items specific to themselves such as their clothing (e.g. safety shoes, unbranded uniform items, etc.), professional licenses, continuing education costs, professional association dues, etc.
- Who is entitled to the profit or loss associated with a business activity?
- Employers reap the benefits (aka profit) or incur the heartaches of a business activity.
- Employees have no control over sharing in the profits or losses from a business activity because they do not have any actual ownership of the business activity, though they may experience a reduction in annual compensation because their work hours are reduced.
- Who controls the business part of the work?
- Relationship Between Business and Worker
- If a business offers benefits to its workers, its workers are most likely employees. Unless required by a law or regulation, a business is not obligated to offer benefits to its workers. The absence of such benefits does not mean that the workers are contractors. The workers can still be employees.
- Does a written contract exist between the business and a worker that defines the relationship?
- A written contract that is executed before the worker begins performing work for the business may be an indicator of that worker’s status as a contractor or an employee. The existence of a written contract designating a worker as a contractor for the business is NOT a guarantee that the worker is not actually an employee and will be deemed as a contractor by a court.
- Written contracts normally cannot require a contractor to have an exclusive agency relationship with a specific business. In other words, contractors must have the freedom to seek, acquire, and serve multiple customers, clients, or patients.
The odds increase significantly for a contractor status to be upheld by a court when a worker serves multiple customers (or clients or patients) simultaneously and that worker has full control over when, where, how, and for whom the work is performed along with determining who performs that work and how those customers (or clients or patients) are acquired by the worker.
- Regulatory or Statutory Mandates
- Some professions are not allowed to operate independently as a business. A law or regulation exists at the federal, state, or local levels that forbid individuals in a specific profession from ever being independent. These people are forced by law to serve some other professionals in a related profession.
For example, dental hygienists are not allowed to practice independently in 43 states within the United States 4. In other words, they must work for (or under the supervision of) dentists, which makes it difficult for them to be legitimately classified as anything other than employees. (Other healthcare professionals encounter similar constraints 5.)
- Some professions are not allowed to operate independently as a business. A law or regulation exists at the federal, state, or local levels that forbid individuals in a specific profession from ever being independent. These people are forced by law to serve some other professionals in a related profession.
Conclusion
If a business owner or manager is uncertain about proper classification of their workers, that business owner or manager can contact an attorney who specializes in employment law or consult with a Certified Public Accountant, such as Andrew Griffith CPA. Alternatively, the default classification of a worker should be as an employee unless persuasive evidence exists that indicates otherwise, and a factually based reasonable belief (not hope or wishful thinking) exists that this conclusion will be upheld in court.