Why should I care about independent contractor misclassification?
Independent contractor misclassification is the practice of treating workers as non-employees when the worker should really be considered an employee—and paid like an employee. Misclassification matters because many of the tax, employment, and employee benefits laws apply only to employees. Companies that treat (and pay) employees as contractors may be violating the law.
How can our company know if a worker should be considered an employee?
Unfortunately, this question is very difficult to answer. The tests for determining who is an employee and who is a contractor differ under different laws and in different jurisdictions. In other words, what is considered an independent contractor relationship under some laws in some locations could be considered an employer-employee relationship under other laws or in other jurisdictions.
For example, tax laws, employee benefit laws and anti-discrimination laws tend to evaluate whether someone is an employee based on a “Right to Control Test.” These tests generally look at the extent to which the company has the right to control how work is performed. If the company cares only about the end result, but exerts no control over how, when and where the worker accomplishes the task, such facts tend to support an independent contractor relationship. On the other hand, if the company sets a worker’s schedule, oversees the project step by step, provides training and covers expenses, then such factors weigh more heavily in favor of an employment relationship.
Wage and hour laws, which determine whether a minimum wage or overtime must be paid, generally apply a different test, called an “Economic Realities Test.” Many factors may be considered, but the main issue here is whether, as a matter of economic reality, the worker depends on the company to earn a living. Even if a company exerts minimal control over how work is performed, a worker may be an employee if the company provides the worker’s main source of income, especially if the company pays the worker’s expenses so the worker will not incur a loss. On the other hand, independent contractors tend to be in business for themselves. They market their services to the public, have multiple clients (even if not at the same time), and may hire helpers. Independent contractors may earn a profit, but they also risk incurring a loss.
Can’t the worker and company just agree that the relationship is a contractor relationship?
No. It can be helpful to use an Independent Contractor Agreement to identify the parties’ rights and responsibilities, but a company cannot contract out of tax, employment or employee benefit law. The facts of the relationship are what matters—not what labels may be used to describe it. If the relationship resembles employment, the worker is an employee, and all of the tax, employment and benefits laws that apply to employees also apply to that worker, regardless of what the parties’ contract might say.
What happens if a company misclassifies a worker as an independent contractor?
Laws that don’t apply to an independent contractor relationship do apply to an employer relationship. For employees, companies must withhold taxes and make deductions for unemployment, Social Security, and Medicare; carry workers’ compensation insurance and generally provide employee benefits. Companies also must pay employees a minimum wage and must pay time-and-a-half to non-exempt employees who work more than 40 hours in a week.
If a worker was treated as a contractor and not an employee, all of these requirements were likely not followed. Consequences for misclassifying may include paying back taxes, penalties, back wages, and other assessments. Companies that misclassify workers on a large scale can find themselves liable for huge sums of money.
I own a small business. What should I do if I think I may have misclassified my workers?
Look closely at the facts of your relationship to your workers. You can usually make changes to enhance the legitimacy of a contractor relationship without disturbing your business objectives.
This “Law You Can Use” consumer legal information column was provided by the Ohio State Bar Association. It was prepared by attorney Todd Lebowitz, a partner with the law firm of Baker Hostetler who helps companies limit risks of worker misclassification. Articles appearing in this column are intended to provide broad, general information about the law. This article is not intended to be legal advice. Before applying this information to a specific legal problem, readers are urged to seek the advice of a licensed attorney