“What's in a name? That which we call a rose by any other name would smell as sweet”
-- William Shakespeare, 1597
“What’s in a name? That which we call an independent contractor could in fact be an employee… depending on who you ask and which law you apply.”
-- Nancy Prager, 2024
Whether a worker is an employee or independent contractor is not as simple as whether the worker is issued a W-2 as an employee or 1099-NEC/1099-MISC as a contractor to use to file their taxes. Nor is it enough to have a contract with a worker that deems the worker to be an independent contractor. Classifying a worker as an independent contractor or employee requires an employer to consider a number of factors under both state and federal law. On the federal level both the IRS and Department of Labor have jurisdiction over how workers are classified. The Department of Labor recently issued final guidance on worker classification that goes into effect on March 11, 2024. Additionally, an employer will need to consider the laws of each state in which they engage team members to determine if a worker is an independent contractor or employee under state laws.
On the federal level, the IRS and Department of Labor take different approaches to classifying workers. However, a business must consider both approaches to properly classify a worker as an independent contractor. Significantly, there can be situations where a worker is an independent contractor for tax purposes but an employee under the FLSA. The following table provides an overview of the different approaches:
IRS | Department of Labor FLSA |
“Right to Control” | “Economic Reality Test” |
20 factors broken into 3 categories: | Six factors: |
1. Behavioral (e.g. Is worker told how to do the job or given flexibility to provide services on own terms?) | 1.Degree and nature of control exercised over workers’ performance; |
2. Financial (e.g. Is worker responsible for expenses incurred providing the service?) | 2. Opportunity for worker to receive a profit or loss from providing the services; |
3. Type of Relationship (e.g. How long is the engagement? Does worker provide services for multiple parties?) | 3. Degree of permanence of the relationship between worker and employer; |
4. Investments worker makes in the business or equipment to perform/provide the services; | |
5. How integral are the worker’s services or contributions to the business; | |
6. Degree of skill the position requires | |
No one factor, or category, is determinative of a worker’s classification. | No one factor is determinative but the more a worker is “economically dependent” on the business the more likely they are an employee. |
Additionally, each state has their own approach to worker classification. Generally, the states are more stringent with a bias toward classifying workers as employees. The majority of states use the “ABC Test” to determine whether a worker is an employee or independent contractor:
The degree over which the business controls the worker’s performance of the services;
The worker provides the services through an independently established enterprise or business; and
The service is either outside the scope of the business for which the services are provided or the services are performed outside of the business’ offices or operations.
The remaining states may rely on the IRS’ Right to Control Test or have unique guidelines that must be considered. For example, in California under AB5 adopted in 2019 if an individual is engaged as an independent contractor through an agreement that contains an assignment of copyright as a “work for hire” the state will likely deem the contractor to be an employee for workers’ compensation and unemployment insurance purposes.
Misclassifying a worker as an independent contractor instead of an employee can result in significant penalties for an employer. The penalties include paying any unpaid wages or benefits that a worker missed as a result of the misclassification as well as additional damages and civil penalties including attorney fees a worker incurs.
Significantly, and surprisingly to many, a contract classifying the worker as an independent contractor cannot override a determination under federal or state law. However, a business can take steps to mitigate the risks of an independent contractor being reclassified as an employee.
Prior to engaging a worker, consider whether they qualify as an independent contractor under each of the IRS, Department of Labor and the state in which they are being engaged.
Clearly advise the worker that they are being engaged as an independent contractor and not as an employee.
Confirm with the worker that they operate as a business by being formally incorporated or organized as a limited liability company and that they provide services to multiple clients.
Have a written agreement with the worker that includes a clear statement that the worker is an independent contractor who will not be entitled to any benefits, compensation terms and any other requirements related to the provision of services.
During an independent contractor’s engagement, the business should also take steps to maintain independence. While engaged, the independent contractor should not be treated the same as employees.
Prager Law provides holistic legal services to our business clients including reviewing and drafting agreements with their goods and services in mind. As evidenced by the evolving framework for worker classification, an ounce of prevention costs less than curing a problem that could be avoided. To that end, Prager Law offers a one-day “in-house” experience during which we will sit in with your team to review relevant agreements and provide a framework for moving forward. Please reach out to schedule a consultation to learn more about our services.