Employee or Independent Contractor

Why Does It Matter?

Fair Labor Standards Act (FLSA) regulates Wage and Hours of employees (applies to employers whose annual sales total $500,000 or more or who are engaged in interstate commerce).

  • FLSA requires employees get overtime for hours > 40 in a given workweek
  • FLSA guarantees employees’ minimum wage
  • FLSA has timekeeping obligations for employers to track non-exempt employees’ hours worked
Internal Revenue Service (IRS)
  • Employers are responsible for paying employees FICA and Social Security taxes.
Why Employees Care?

Advantages of being an Independent Contractor (Form 1099-MISC):

Some Employees Want to be Designated as an Independent Contractor:

IRS Schedule C tax advantages include the ability to deduct expenses from income such as a home office, supplies, phone, car, etc.

Disadvantages of being an Independent Contractor:

  • Independent Contractor’s don’t get overtime or benefits such as paid vacations or healthcare
  • Independent Contractor’s don’t get paid sick leave
  • No Workers Compensation insurance in case of workplace injury
  • Anti-discrimination laws do not protect you
  • Independent Contractor’s pay both the employer and employee portion of FICA tax
    • Social Security tax: The 6.2 percent employer component (half of the 12.4 percent total)
    • Medicare tax: The 1.45 percent employer component (half of the 2.9 percent total)

Independent Contractor’s are responsible for an additional 7.65 percent of their earnings in FICA taxes

NOTE: Just because employee desires treatment as an Independent Contractor does not mean he or she is one!

Why Employers Have Incentive to Misclassify

Independent Contractor’s are generally cheaper labor

  • No health benefits
  • No FICA
  • No paid vacation
  • No overtime
  • No retirement benefits
  • No unemployment benefits
  • No workers comp
  • IC’s cannot unionize

BEWARE: Penalties for misclassification are STEEP!

U.S. Dept of Labor’s New Economic Reality Test

Previously, a multifactor economic reality test was used by courts since the 1980s and the DOL since the 1950s attempting to balance and apply multiple factors to countless employment relationship fact patterns often with lack of clarity.

In January the U.S. DOL adopted new rule which reaffirms an “economic reality” test to determine whether an individual is in business for him or herself (independent contractor) or is economically dependent on a potential employer for work (FLSA employee).

The DOL’s new test gives permission for gig economy companies to continue to classify most of their workers as independent contractors.

DOL’s Core Factors

New DOL Rule identifies two "core factors" that can be used to determine whether a worker is an Independent Contractor or an Employee:

  1. The nature and degree of control that the employer has over the work
  2. The worker's opportunity to recognize profit or loss based on his or her efforts and investment
When Two Core Factors Lead to a Different Conclusion, the Analysis Continues

Three other factors can be used as additional "guideposts":

  1. The amount of skill that is required to perform the work;
  2. The degree to which the relationship is permanent rather than short-term or intermittent; and
  3. Whether the work performed is part of an "integrated unit of production", meaning that the type of work is central to the employer's business.

When performing the above analysis, the actual working relationship of the parties involved is determinative of the classification. Remember that calling an individual an "Independent Contractor" in an offer letter or employment contract does not necessarily make them so. Rather, the circumstances of the employment relationship dictate the classification.