Last week, we reviewed information from a recent NAHB presentation with expert panelists discussing recent efforts to step up enforcement and to punish worker misclassification. The potential costs of misclassification are enormous, both in terms of fines and back payments of taxes, benefits and so forth.
In this second installment, we’ll review the presentation’s focus on evaluating worker classification and getting it right, especially in an industry with many legitimate independent contracting arrangements. In determining whether someone is an “employee” vs. an “independent contractor” (IC), it’s important to review the typical worker categories:
Regular Employee: A person rendering an actual service in any business for an employer, whether gratuitously or for wages
Contingent Workers: Part-time, temporary, seasonal, or specialized workers employed for a limited period of time or an identified project (nearly 25% of the nation’s workers)
Joint Employee: Workers typically supplied by employee leasing firms or temporary staffing agencies
IC (Independent Contractor): A person who renders services for specified recompense or a specified result under the control of the user of services or a specified result under the control of the user of services only as to the result of the work, and not as to the manner or means by which the result is accomplished
Classification Criteria: Employee or IC?
There is neither a single nor simple test used to determine whether a worker is an IC or an employee. The tests applied are complex and subjective, and differ depending upon the law at issue. For example, the Civil Rights Act, the Fair Labor Standards Act, the National Labor Relations Act, and the Employee Retirement Income Security Act each use a different definition of employee and different tests or criteria to definition of employee and different tests or criteria to distinguish ICs from employees. The government and courts use several different tests for determining employment status depending upon the law involved although it is important to note that states can and do use other tests:
- IRS 20-factor “Right to Control” test
- “Economic Realities” test
- 3-factor test
- Hybrid test: combination of “Economic Realities” and “Right to Control” tests (or other tests)
The IRS, for example, typically uses the 3-Factor Test to determine if a worker is an employee or an independent contractor. For audit purposes, IRS auditors use a modified version of the 20-Factor Test that focuses on three factors:
- Behavioral Control Factors
- Financial Control Factors
- Relationship of the Parties Factors
The IRS Three-Factor Test considers the work that is being performed and the business context in which it is being performed.
The Fair Labor Standards Act employs the “Economic-Realities” Test to properly determine worker classification:
- Control over the worker
- Workers’ opportunity for profit or loss
- Workers’ investment in equipment or materials required for task
- Whether the services rendered require a special skill
- The degree of permanency and duration of the working relationship
- The extent to which the services rendered are an integral part of the employer’s business operations
There are some “best practices” advised for your contracting situations so that you do not veer into the territory of being an employer:
- Do not over-utilize contractors. Contractors should not be hired to perform work central to the business (e g perform construction or bookkeeping work) but business (e.g., perform construction or bookkeeping work) but rather for the “special expertise” they have.
- Avoid hiring/retaining former employees as contractors.
- Allow the IC (or vendor) to determine the method and means of accomplishing the project.
- Have contractor use own equipment.
- Do not restrict work to a specific individual…contract with the “vendor”.
- Do not require exclusivity of work or allow IC to perform services for other companies.
- Do not require individuals to provide daily or weekly reports of their hours worked hours worked.
- Pay by the project (Do not pay a day or hourly rate).
- Do not allow ICs to perform work indefinitely. Work performed should be for a discrete time frame.
- Use of staffing agencies (But be careful to avoid joint employer status!).
Finally, experts advise you enter into written agreements with ICs before the work begins. Payment should be project specific, rather than hourly, etc. There should be a complete list of tasks to be performed and results to be obtained. There should be a contract term or termination date and you should affirm that there are no benefits/expenses to be received.
For more information and to view the slides from NAHB’s expert panel, click here to download.