Gimme 5: What Every Lawyer Should Know about the Difference between Employees and Independent Contractors
1. What is the fundamental difference between an employee and an independent contractor? The threshold difference between an employee and an independent contractor is that an employee is hired to provide services on a regular basis in exchange for compensation and is subject to the control of the employer in terms of working hours, location, and provision of tools to perform the job. Conversely, an independent contractor is a worker who contracts to provide specific services to a company according to contractual conditions but is not subject to the same level of control as an employee of that company.
Practice Pointer: This is a basic definition. Before making any final decision as to the status of an individual, an in-depth analysis must be conducted that considers many additional factors.
2. How does one decide who is an employee and who is an independent contractor? In California, no one test is controlling on the determination of whether a worker is an employee or an independent contractor. Under the common law, a worker is an independent contractor only if the company has no “right to control” the manner and means by which the worker accomplishes tasks, including, for example, by providing the tools of the trade (desk, office space, computer), requiring that the worker work a certain schedule, or highly supervising the work.
The Internal Revenue Service uses a 20-factor test to make the classification with no single factor being determinative. The 20 factors have been developed based on an examination of cases and rulings considering this very topic. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed. Some factors include the right to discharge, requiring oral or written reports, performing work on a company’s premises, hiring and supervising assistants, and receipt of training by the worker from a seasoned employee.
Notwithstanding these tests, to determine if a worker is properly classified, California courts evaluate various factors including those identified in S. G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989). These factors include the degree of skill required to perform the job, the kind of occupation, the regularity of the work in the business of the company, the method of payment, whether by time or by job, and whether the work is a part of the regular business of the principal. Id. at 351. A company’s determination that a worker is an independent contractor and a signed contract to that effect may not control a court’s analysis of whether the classification is correct. Instead, courts will weigh the intertwining factors to determine which classification should be applied.
Practice Pointer: Due to the multitude of tests that may be applied depending on the specific facts, classification decisions should be made with the advice of an attorney specializing in this area of law. Companies should not use single factors to determine this classification. It is also important to look at each worker individually and not the classification of jobs.
3. Why does it matter? The impact of classification is multifaceted. For example, for every employee, companies pay payroll taxes, reimburse for business expenses incurred while performing the job, and make payments under workers’ compensation, unemployment insurance, disability insurance, and social security. For its employees, employers are also required to comply with minimum wage and overtime laws, provide applicable meal periods and rest breaks, and provide benefits for those individuals who meet the employer’s benefit plan requirements.
In contrast, a company that hires an independent contractor is generally free from all requirements associated with employment status. Instead, companies must file IRS Form 1099-MISC annually if they pay the contractor more than $600 per year and leave contractors to compute their own taxable income and pay applicable taxes. Additionally, company liability for tortious acts and omissions by an independent contractor is severely limited as compared to acts by an employee precisely because the relationship lacks the control, authority, and supervision found in an employer-employee or principal-agent relationship.
Practice Pointer: Classification of a worker as an employee or independent contractor does not end the company’s need for legal advice. Compliance with wage and hour, benefits, and tax laws should be carefully monitored as to both classes of workers to avoid penalties and litigation. There is also the potential for classwide liability in misclassification cases. Thus, it is important to carefully scrutinize with legal counsel any blanket classification of employees as independent contractors to protect against possible broad-sweeping liability.
4. What is the perception of independent contractor status? Classifying workers as independent contractors presents significant legal risks even when done properly because it is currently a disfavored classification. Courts and agencies often view such classification as a means for companies to avoid legal obligations of paying employee benefits and providing them legal protections. Because of this skepticism, courts and agencies, particularly in California, generally favor classifying an individual as an employee. Therefore, it is essential that a company be aware of practical classification pitfalls because, when in doubt, courts and agencies most likely will find that a worker should be considered an employee.
5. What is the impact of incorrectly classifying workers? Misclassification of workers can expose companies to a broad range of liability including payroll taxes, unemployment insurance, health insurance premiums, pension contributions, stock options, vacation, wages, attorneys’ fees, and punitive damages. Indeed, recently, the federal legislature began taking an even harsher view of worker misclassification. A bill recently introduced into the Senate (S. 3648) proposes to amend the Fair Labor Standards Act to clarify that misclassification is prohibited and allow affected workers to seek liquidated damages and civil penalties. S. 3648 would allow government agencies to share information on misclassification cases as well as mandate government audits in industries with poor classification histories. It also would require state unemployment insurance agencies to conduct audits and affirmatively identify companies misclassifying employees. The bill also would require companies to keep records on and notify workers of their classification and their right to challenge that classification.