Who Is an Employee? Determining Independent Contractor Status

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Many small businesses rely on independent contractors for their staffing needs, but doing so raises special concerns. Independent contractors, by definition, are self-employed and because they are not employees, independent contractors are not covered by employment, labor, and related tax laws.

There are many benefits to hiring independent contractors such as savings in labor costs, reduced liability and flexibility in hiring and firing. However, employers that misclassify workers as independent contractors rather than employees may face serious consequences. Employers can be liable for unpaid wages, including overtime and minimum wage, federal and state income taxes and penalties, Social Security, Medicare and unemployment, workers’ compensation benefits, and other employee benefits, including health insurance, retirement, etc.

How Do You Decide?

There is no single test for determining whether an individual is an independent contractor or an employee under the Fair Labor Standards Act. However, the U.S. Department of Labor (“DOL”) suggests following factors be taken into account:

  1. The extent to which the services rendered are an integral part of the principal’s business.
  2. The permanency of the relationship.
  3. The amount of the worker’s investment in facilities and equipment.
  4. The nature and degree of control by the principal.
  5. The worker’s opportunities for profit and loss.
  6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  7. The degree of independent business organization and operation.

Whether a person is an independent contractor or an employee generally depends on the amount of control exercised by the employer over the work being done.

Reality Check

The DOL, IRS and state agencies are actively working together to ensure that employees receive the protections to which they are entitled under federal and state law by cracking down on employers that misclassify workers. Employers are encouraged to perform routine audits to ensure that each worker is properly classified.