Staying on Safe Ground When Engaging Independent Contractors

It's not a new problem but, for employers of all kinds, it's a challenge that's only grown in today's so-called "gig economy." We refer, of course, to the proper handling of independent contractors.

Engaging these workers has its advantages. Typically, they should need little to no training, and you don't have to offer them benefits or remit payroll taxes for their compensation. But should you inadvertently blur the line between independent contractor and bona fide employee in your treatment of them, harsh consequences may follow.

What Does the Law Say?

The Fair Labor Standards Act (FLSA) doesn't strictly define the term "independent contractor." Courts, however, generally have focused on several factors related to the "economic reality" of relationships between employers and workers.

The U.S Department of Labor (DOL) will likely continue to lean on U.S. Supreme Court rulings for guidance. The Court has repeatedly stated that no single rule or test applies to determine employment status under the FLSA. Rather, the totality of circumstances generally determines a worker's status, including the:

1. Extent to which the services rendered are an integral part of the employer's business,
2. Permanency of the relationship,
3. Amount of the alleged contractor's investment in facilities and equipment,
4. Nature and degree of control by the employer,
5. Alleged contractor's opportunities for profit and loss,
6. Amount of initiative, judgment or foresight in open market competition with others required for the success of the claimed independent contractor, and
7. Degree of independent business organization and operation.

The Supreme Court also has held that the time or mode of pay isn't determinative.

The DOL has identified other factors it deems relevant, including:

• Where the work is performed (remotely or on-site),
• The absence of a formal written employment contract or the existence of an "independent contractor agreement," and
• Whether the work is licensed by the state or local government.

Providing workers with IRS Form 1099, "Miscellaneous Information" instead of Form W-2, "Wage and Tax Statement," doesn't automatically define them as independent contractors.

Keep in mind that some states have even more restrictive tests. Moreover, the fact that workers qualify as independent contractors under another federal law doesn't guarantee they qualify under the FLSA.

How About the IRS?

When scrutinizing relationships between employers and independent contractors, the IRS tends to apply a different test than the DOL. Traditionally, the tax agency has applied a 20-factor test to determine whether a worker is an employee. However, more recently, it tends to focus on three areas related to the employer's right to control the work:

1. ‍Behavioral control. To what extent do instructions, training and evaluations demonstrate that you have a right to control how the worker performs the work — regardless of whether you actually exercise that right? Workers who require your approval before taking certain actions probably are employees.‍
2. Financial control. Do you have a right to control the economic aspects of the work? For example, does the worker incur significant unreimbursed expenses or is the individual available to work for other companies? Both circumstances suggest the person is an independent contractor.‍
3. The parties' relationship. How do the two parties view and treat each other? For example, providing employee benefits tends to indicate an employer-employee relationship. Conversely, a short-term arrangement with a defined objective is more indicative of an employer engaging an independent contractor.

Who Can Help?

As mentioned, failure to properly determine worker status can prove costly. If, following an investigation, the DOL or IRS reclassify independent contractors as employees, you may have to make up the unpaid wages and employment taxes for the individuals in question. Plus, you could end up on the hook for workers' compensation premiums, unpaid leave and other benefits. Fines and penalties are possible as well. Work closely with your attorney and CPA to ensure that you handle all your independent contractors carefully and properly.