The differences between the two statuses are not always easy to determine
By Steven E. Abraham
‘Generally speaking, it is much more advantageous if an organization can treat its workers as independent contractors. Nevertheless, it’s not always clear into which category a worker falls.’
A business frequently utilizes the services of individuals to do work for the business. An interesting legal question is how those individuals should be categorized.
Usually, they are considered employees. But it’s also possible that they may be considered independent contractors. The differences between the two statuses are significant, but it’s not always easy to determine.
Employees are covered by a plethora of federal and state employment laws, such as the Fair Labor Standards Act Title VII of the Civil Rights Act of 1964 the New York State Human Rights Law, etc. Independent contractors are not.
When employees are hired, the organization must fill out an I-9 form, certifying the employees’ eligibility to work in the United States. This is not required of independent contractors.
When an employee is hired, the employee fills out a W-4 form for tax purposes. Independent contractors fill out a W-9 form.
At the end of the year, the organization must provide employees with a W-2 form listing the wages paid to the employee during the year. Independent contractors, on the other hand, receive a form 1099 if they are paid more than $600 in a calendar year.
Organizations must notify the federal unemployment insurance agency of any employees; no such notice is made for independent contractors.
There are legal requirements regarding when employees must be paid. In New York state, employees must be paid weekly or semi-monthly, depending on the occupation. There are no such requirements for independent contractors.
Generally, it is much more advantageous if an organization can treat its workers as independent contractors. First, the potential legal liabilities to independent contractors are much less than the potential liabilities to employees. The organization benefits financially if it can treat its workers as independent contractors as well, as Social Security taxes need not be paid, and unemployment insurance contributions need not be made. In addition, workers’ compensation insurance need not be provided for independent contractors.
Nevertheless, it’s not always clear into which category a worker falls.
How to know the difference
Since the differences between the two categories of workers are so important, it is crucial that the organization be able to classify them correctly. This is often difficult, however, because there are different tests that the courts will use to make this determination.
According to the New York State Department of Labor, an employer-employee relationship may exist if the organization:
• Chooses when, where, and how the workers perform services
• Provides facilities, equipment, tools, and supplies
• Directly supervises the services
• Sets the hours of work
• Requires exclusive services (An individual cannot work for competitors while working for you.)
• Sets the rate of pay
• Requires attendance at meetings or training sessions
• Asks for oral or written reports
• Reserves the right to review and approve the work product
• Appraises job performance
• Requires prior permission for absences
• Has the right to hire and fire
The federal Department of Labor refers to the following factors which the courts have used in making the determination:
The extent to which the services rendered are an integral part of the principal’s business.
• The permanency of the relationship.
• The amount of the alleged contractor’s investment in facilities and equipment.
• The nature and degree of control by the principal.
• The alleged contractor’s opportunities for profit and loss.
• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
• The degree of independent business organization and operation.
It should be noted that when Donald Trump was president, the Department of Labor stated that the agency would use what was known as the “economic realities test” to determine an individual’s status. That status stated that two “core factors” were the ones to be used:
• The nature and degree of the worker’s control over the work
• The worker’s opportunity for profit or loss.
This rule was generally thought by most to make it much easier for organizations to categorize workers as independent contractors; it never was enacted, however.
The rule was issued by the Trump administration’s DOL on Jan. 7 and was set to take effect on March 8. It was withdrawn without ever taking effect after President Biden was elected, however.
And the IRS essentially uses what is known as the 20-factor test:
• Does the employer dictate when, where and how the worker will complete the work? If so, the worker could be classified as an employee.
• Is there a minimum number of training hours required before the worker is permitted to begin the job? Is the employer supplying the training? This suggests an employer-employee relationship.
• Is the work heavily integrated with business operations? Is the success of the business heavily reliant on the satisfactory completion of the work by the worker?
• Must the work be performed by a certain person and no one else? ICs are typically free to outsource their work, whereas employees are expected to perform the work themselves.
• Does the employee have control over the worker’s assistants? Does the employer dictate who the worker uses as an assistant or even pay the assistant? This suggests an employer-employee relationship.
• Has the worker been performing the same job and the same tasks for the same employer for an extended period of time?
• Does the employer dictate the hours or days when the work must be performed? This is likely.
• Does the employer demand that the worker work a minimum number of hours that equates to full-time work? Since this would prohibit the IC from seeking work elsewhere, this would likely be considered an employer-employee relationship.
• Does the employer require the worker to perform the job at a certain physical location? Could the work practically be performed elsewhere instead? This is the marking of an employment relationship.
• Is the schedule of the work to be performed dictated by the employer? This indicates a level of control that is more employer-employee than employer-IC.
• Does the worker have to check in with employer with status updates on the work being performed? Are written or oral reports a requirement? If so, the worker may be an employee.
• How is the worker paid? Is there a particular payment schedule set in place, such as hourly, weekly, or monthly? ICs typically get paid in a lump sum once the work is completed
ICs typically bear their own travel and business expenses, whereas employees are usually entitled to some sort of compensation for business or travel expenses
How do the workers get the work done? Is it with company-supplied tools and equipment or are they supposed to provide their own tools and equipment to complete the work? Employees typically use company equipment, whereas ICs are expected to provide their own.
ICs do not typically invest in the facilities where they perform work. Does the worker invest in the company premises? If so, they may be an employer rather than an IC.
ICs do not share in profit or loss. Employees may be part of a profit-sharing plan.
Is the worker able to work elsewhere? If not, they may be classified as an employee.
Are the worker’s skills available for general hire to the public? If not, it’s more likely an employer-employee relationship.
What are the circumstances under which the employer can withdraw offers to work? If there is a contract in place, it may or may not suggest in IC relationship with the employer.
Does the worker have the right to turn down ongoing work? If so, that’s more of an IC-employer relationship.
It also should be noted that the Biden administration prefers something known as the three part ABC test.
This test has three essential components. An individual performing any service shall be considered an employee and not an independent contractor, unless:
The individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of service and in fact;
The service is performed outside the usual course of the business of the employer; and
The individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.
It should be noted that courts might apply a different set of criteria to determine an individual worker’s status. The tests just listed are the ones utilized by various state and federal agencies, but courts are not bound to any of those tests. A court is at liberty to use a different set of criteria.
Finally, it should be noted that it is also possible for an organization to set up the relationship with its workers in certain cases. For example, if the organization wishes to have its workers considered independent contractors the organization might be able to establish a working relationship in such a way that is more likely that the workers will be considered independent contractors, by utilizing the tests discussed above.
Steven E Abraham is a professor in the School of Business at SUNY Oswego. He received his B.S. from Cornell University, his J.D. from NYU school of Law and his PhD from University of Wisconsin, Madison. He teaches courses related to employment law, union–management relations and human resource management.