A hot topic in employment law right now is the proper classification of a worker as either an employee or independent contractor.  Employees, of course, have the benefit and protection of numerous state and federal laws (regarding minimum and overtime wages, workers’ comp and unemployment, anti-discrimination laws, collective bargaining, and others).  Employees also create added cost to the employer, when compared with contractors, such as employment tax, benefits, and other overhead.

Contractors, on the other hand, are not protected by employment laws, but are subject instead to whatever agreement is signed between the contractor and the hiring company, and that allows for companies to have skilled workers at a reduced cost.  Generally, contractors must fund their own professional liability and medical insurance, pay their own taxes, and purchase the tools and equipment needed to do their work.  Remember, typically, an independent contractor is someone that has a specialized skill or ability, advanced education in their area of expertise, can work with little or no supervision, and simultaneously performs services for multiple clients, not just you.  Very different from an employee.

In January 2021, the US Department of Labor proposed a set of guidelines that would standardize the test regarding how a worker should be classified.  In May 2021, the DOL rescinded that proposal given that the new administration is seeking to provide greater legal protections for all workers, including contractors, than the previous guidance would have offered.

With no current federal rule, companies must look to state statutes and caselaw to help them determine what factors to consider to properly classify their workers. The following test factors provide the types of questions you need to consider when bringing on a worker.

The Economic Reality Test asks whether the worker is truly operating a business (an independent contractor) or is economically dependent on the employer (an employee)?  The 6 factors create a “balancing test” that business owners can use to determine where their workers fall.  Companies must weigh each factor; some may indicate that the worker should be an employee, while others may lean toward contractor.  No one factor stands alone in making this determination and factors which are relevant in one situation may not be relevant in another.

Integration : Are the worker’s services an integral part of the employer’s business? Do they significantly impact the company’s overall success?

Permanency : Has the worker worked for the employer a long time?  Or do they work on a project basis?

Investment : Has the worker invested in owning facilities, tools, equipment? Or do they use the resources provided by the company?

Control : Does the employer control the worker’s performance, schedule, etc.?  Or does the worker have the right to work for competitors and to take on clients of their own?

Exposure : What are the worker’s opportunities for profit and loss related to the fees charged, the clients accepted, and the cost of necessary resources to do the job properly?

Skill : What level of skill does the job require – routine tasks with little training, or more specialized skills that require initiative, judgment, independence?

Many states use the ABC Test to determine how a worker should be classified.  If the company cannot prove A, B and C, then a worker would be classified as an employee, even if there is a valid independent contractor agreement, as most states would look to the reality of the work situation and not to the letter of an agreement.

With this test, Prong B is typically the hardest one to comply with.  Many companies hire contractors to supplement their work force and perform tasks that are integral to the company’s mission.  For instance, a company that designs websites might engage contractors who are skilled website designers.  Likewise, a medical practice might bring on licensed physicians as contractors to provide medical services to their patients.  In both cases, these situations violate Prong B of this test.

It’s critical to check the laws of your state – some states that have adopted the ABC Test do not require Prong B, and others may have certain exceptions, such as those permitting highly educated and licensed professionals to work as contractors.

The IRS test considers the degree of control that the hiring entity has over the worker vs. the level of independence the worker may exert.  According to IRS.gov, facts that provide evidence of the degree of control and independence fall into three categories:

Behavioral : How much control does the company have over the worker’s tasks, method of working, and where and when the work is done?

Financial : Does the company control the financial aspects of the worker’s job, such as the rate and frequency of pay, reimbursement for expenses, and purchase of the tools needed for the worker to do the job?

Type of Relationship : Have the worker and company executed an independent contractor agreement? Are employee benefits, retirement plans, vacation, or paid time off provided? Does the relationship LOOK like an employment relationship, or does it appear to be a relationship between independent businesses?

In 2016, A.R.S. 23-1601 became effective, providing for a Declaration of Independent Business Status which would establish a rebuttable presumption of an independent contractor relationship.  The terms of this declaration are similar to the factors presented in the above tests. Even if fully signed by the worker and the company, this presumption can be rebutted if a worker claims that an employment relationship existed instead and can prove that the actual relationship is not substantially consistent with the terms of the declaration.

From a federal standpoint, we don’t know.  The DOL may (or may not) propose a new federal rule that provides a uniform test or analysis.

In the interim, remember that there is no “safe harbor” for misclassifying, even unintentionally.  If there is a dispute, the burden will fall on the hiring company to prove that a worker was properly classified as a contractor (using the above test factors).  If the decision goes against the company, it may be liable for back wages and overtime, employee benefits, tax obligations, and penalties.

Whether working under any potential federal rule or under current state laws, there are steps you can take to protect your business by establishing a relationship with a worker that tips far in the favor of a contractor relationship.  (Of course, hiring a worker as an employee is always acceptable, and legally, is the safer way to go.)

As we’ve seen in just the last 5 months, this area of employment law is very fluid right now.  Stay up to date on the developments so that you remain compliant and reduce your risk of liability for misclassifying.  If I can be of assistance as you review your current worker classifications, or if you are looking to bring on new workers, don’t hesitate to call!

NOTE: THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES. IT DOES NOT CONSTITUTE LEGAL ADVICE, NOR DOES IT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. EACH SITUATION IS DIFFERENT. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE YOUR LEGAL RIGHTS, REMEDIES, AND DUTIES.

By Wendy M. Anderson, Esq.
Law Office of Wendy Anderson, PLLC
480-825-4509
Contact Me Today

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