Understanding Independent Contractor vs. Employee Classifications: A Small Business Guide
Independent contractors are a lifeline for small businesses. Although these organizations may have some employees on their payroll, they often work with independent contractors to save costs on hiring more permanent hands, especially since they’re operating on a limited budget.
That said, hiring workers is one thing; classifying them properly is another. While the former likely won’t get you in trouble, the latter could put you at risk of severe financial penalties, including paying the back taxes of affected staff.
To avoid this scenario, it’s critical to understand employee classifications according to US labor laws. In this article, we’llprovide a guide to help you categorize the members of your workforce in compliance with federal regulations. Let’s dive in:
Classifying Employees Based on the Common Law Rules
The Fair Labor Standards Act (FLSA) uses the economic reality test to determine whether an individual falls into theemployee or independent contractor category. This test considers six vital factors for worker classification:
- The degree of the employer’s right to control the manner in which the work is to be performed.
- The worker’s opportunity for profit or loss is based on their managerial skill.
- The worker’s investment in equipment or materials required for their task.
- The extent to which the service rendered is an integral part of the employer’s business.
- Whether the service rendered requires a special skill.
- The degree of permanence of the working relationship.
To help business owners interpret these factors and determine the classification of their workforce, the Internal Revenue Service (IRS) provides some common law rules or questions to consider:
Behavioral Control
According to the IRS, the question employers should ask and answer under this rule to classify a worker is: Does the company control or have the right to control what the worker does and how the worker does the job?
Usually, employees don’t have control over factors like work hours, where tasks and duties are executed, and the manner or equipment used in their execution. In contrast, independent contractors have more freedom in these areas. They can determine where, when, and how they work.
Financial Control
This rule examines the level of control that employers have over the financial aspects of the individuals on their payroll. The defining question here is: Does the business direct or control the economic and business aspects of the worker’s job?
The IRS states that some factors business owners should consider while answering this question include how the individual is paid, who supplies the equipment, and whether the organization reimburses expenses.
Generally, employees receive wages on a salary or hourly basis, with tax and Social Security deductions made by the employer. Organizations also provide the tools and supplies required by employees for their duties.
The scenario differs for independent contractors, who receive their earnings per project, provide the required equipment, and have to handle taxes themselves.
Type of Relationship
Business owners can determine the classification of workers under this rule based on the following questions: Does the employment require a written contract with employee-type benefits? Will the relationship continue, and is the work performed a key aspect of the business?
Employees typically sign contracts that specify certain benefits that they’re eligible for, such as pension plans, paid vacations, and insurance. They also have a long-term relationship with the company. Finally, if an individual’s duties are directly related to the core operations of the company, then they fall under the employee category.
In comparison, independent contractors don’t have access to pension or insurance benefits from their employers, and the duration of the relationship usually lasts till the end of the project. The responsibilities and tasks they handle are also rarely related to the organization’s core functions.
According to the IRS, businesses must evaluate all three common law rules to determine the classification of a worker. In other words, one factor alone doesn’t determine an individual’s designation as an employee or independent contractor.
Work With Expert Legal Counsel to Comply With FLSA Employee Classifications
Categorizing employees in line with the Fair Labor Standards Act can be a tricky task for small business owners. Usually, an individual can fulfill one or two of the common law rules and fail to meet the others.
Misclassifying a worker in this case can lead to lengthy legal battles and costly financial consequences. To avoid these outcomes, expert legal assistance becomes a necessity for small businesses.
An experienced attorney can help you understand the laws around worker classifications and review your company’s employee classifications to comply with the FLSA.
At the Law Office of Sheri Oluyemi, we can help your business stay within the boundaries of FLSA employee classification regulations and avoid the costly penalties that can arise from misclassifying your staff. We’ll evaluate your company’s classifications and provide expert counsel to keep you compliant with federal and state laws. Contact us today to schedule a free teleconference consultation.
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