Employee vs. Independent Contractor: What is the Common Law Test?

employer vs. contractorAre you an employee or an independent contractor (IC)? The line is often blurry. In some situations, either or both parties are simply unaware of the legal distinctions between these worker categories. In other cases, the misclassification may be purposeful. As an employee, you enjoy numerous advantages over working as an IC, and your employer has more responsibilities and financial obligations. Sometimes, this motivates an employer to misclassify their employees as ICs.

We’ve created this guide to help you identify the differences between these worker categories and to understand the varying privileges, rights, benefits and responsibilities between the two.

Defining Key Classifications

As a worker in the U.S., you may fall into one of the following categories:

  1. Independent Contractor:

    Self-employed workers who perform job duties/work on a contracting basis for individual clients or businesses. Freelancers are independent contractors.

  2. Common-law Employee:

    Workers who perform job duties/work under the control and direction of an employer/business. Temporary staffers are typically considered common-law employees of both their temp agency and the companies they provide services to.

  3. Statutory Employee

    : These employees are a sort of hybrid between IC’s and common law employees. This classification applies to explicit groups (Specific agent drivers or commission drivers; full-time life insurance agents; full-time traveling or city B2B salespersons; telecommuters who work from home on employer-provided equipment, supplies and/or goods during employer-mandated work hours/schedules.)

  4. Statutory Nonemployee:

    These workers fall into three categories — licensed real estate agents, direct sellers, and companion sitters who don’t work for a placement service. These workers are self-employed when they contract with a business via a written agreement to perform their services.

  5. Government Worker:

    Public Officers and Officials and Elected Officials. Examples of public officers are members of a legislative body, mayors, governors, tax assessors, advisory board members, secretary of state, the vice president and the president. Most public and elected officials are classified as employees. However, some of these individuals are paid on a fee basis and classified as self-employed. Very specific rules, situations and exceptions apply.

How the Federal Government Weighs In

Uncle Sam has a stake in a worker’s classification. It determines who is responsible for employment-related federal withholdings. To make their determination for federal workers, the government looks closely at the relationship between the worker and the company they provide services to. They examine three categories in this relationship to apply the Common Law Employee Test:

Control Over Work Duties/Behavioral

ICs have a lot of control over how they perform their jobs. Typically, it’s the end result or work product that the IC’s clients concern themselves with. Where you perform your work has bearing, as well as whether you’re penalized for missing worksite meetings, and who hires any helpers or assistants you may need. If you’re classified as an IC, but the company you work for is directing how you do your job, provides you with training, work instructions and other detailed oversight, you should probably revisit your worker classification. You just may be a common law employee.

Control Over Finances

As an IC, you’re responsible for obtaining and maintaining the tools you need to do your work, whether that’s office equipment or heavy equipment. Your profit and loss balance sheet is largely under your purview, and if you have business-related expenses, the best way to cover them is to include those costs on your job bid and IC agreement. When a company encroaches on these and other related financial control areas, they may be establishing an employer/employee relationship, rather than an IC/client arrangement.

Relationship Between the Company and the Worker

Are you receiving employee benefits, sick time and vacation pay? How permanent is your work arrangement with the company you work for? Do you have a contracting agreement? Are your services essential to the success or day-to-day business of the company? Do you provide services for more than one company at a time or are you prevented from engaging in competitive projects? These factors and others defining the worker/company relationship can help the federal government better understand whether you’re working as an employee or an IC. The less freedom you have, the more likely it is that your status is that of an employee.

Withholdings

When you’re classified as an employee, your employer sends you a W-2 in January to report your income for tax purposes. At a minimum, your employer withholds Social Security and Medicare from your checks. They pay in a share of these payroll taxes as well.

As an IC, you may receive a Form 1099 MISC, rather than a W2. There are rarely any mandatory tax withholdings from your job payments. Instead, you are responsible for meeting your tax obligations with the IRS directly.

Laws Impacting Employee vs. Independent Contractor Rights

Tax liability is far from the only legal area impacted by whether you are classified as an IC or an employee. In determining the worker’s classification, historically, the Department of Labor and Courts across the nation have applied the economic realities test. This method looks at how dependent a worker is on the company he works for. The main 6 factors are:

  1. How much control you have in the performance of your job
  2. How vital your work is to the company you work for
  3. How permanent the working relationship is
  4. Who pays/invests in your worker equipment/supplies
  5. Your control/opportunity in your own profit and loss
  6. The level of skill required to perform your job and how independent your business is

The following laws protect and benefit employees. They don’t apply to ICs.

Fair Labor Standards Act (FLSA)

The FLSA establishes wage and hour requirements for most workers across the country, setting the minimum wage and mandating overtime pay, among other protections.

Workers’ Compensation

When an employee is injured on-the-job, workers’ comp benefits provide medical care, partial wage replacement and disability benefits, when applicable. Employers purchase this coverage.

Family Medical Leave Act (FMLA)

Employees are eligible for unpaid leave for qualifying medical, health issues and specific family obligations.

Employee Retirement Income Security ACT (ERISA)

ERISA, under the DOL, is tasked with protecting retirement and welfare benefit plans from abuse and mismanagement. This helps safeguard employee interests in these types of plans.

Affordable Care Act (ACA)

Under the ACA, businesses with at least 50 employees working 30 hours or more per week must offer insurance coverage.

Unemployment Insurance (UI)

Unemployment insurance provides partial wage replacement benefits to eligible workers who’ve lost their jobs. Employers pay for this insurance to protect employees.

State Laws

Individual states must follow federal guidelines for classifying employees and independent contractors. But they often use differing standards and tests to make their determination. Some states are stricter than others about this issue. Many states apply the economic realities test.

Sources:

https://www.irs.gov/taxtopics/tc762
https://www.irs.gov/pub/irs-pdf/fss8.pdf
https://ogletree.com/shared-content/content/blog/2017/june/dol-withdraws-independent-contractor-and-joint-employment-guidance
https://www.acf.hhs.gov/css/resource/the-difference-between-an-independent-contractor-and-an-employee