Co-Authored By: Jack E. Moran, Principal & Michael P. O’Neil, Law Clerk
With the so-called gig economy gaining momentum in recent years, the number of independent contractors has consequentially exploded. In 2022, approximately 60 million Americans were classified as having performed some type of independent contracting, which is roughly 36 percent of the country’s workforce. By 2030, approximately 50 percent of U.S. workers are projected to be considered independent contractors. In the post-pandemic world, many individuals have realized the economic opportunities available to them through independent contracting. These new and emerging industries include rideshare and food delivery services, consulting, web development, graphic design, tutoring, and more.
With the increase in the number of independent contractors and freelance services being performed, it is important for both workers and employers to understand who qualifies as an employee vs. an independent contractor. A 2020 analysis from the National Employment Law Project estimated that as many as 30 percent of employers may misclassify their workers.
Decisions regarding classification can have profound effects on the rights of all involved. For example, misclassification of workers as independent contractors can leave employers on the hook for back pay of wages and overtime, unpaid tax withholdings, liability payments, benefits, and numerous other fees. From the workers perspective, independent contractors are generally considered self-employed individuals who are thus not entitled to the same level of legal protection and benefits that employees enjoy. These include protections such as civil rights (discrimination, harassment, retaliation) laws, overtime pay, minimum wage requirements, workers’ compensation, and other benefits.
For tax purposes, the IRS uses common law principles to determine if a worker is an independent contractor or an employee. Previously, a “20 factor test” was used to determine employee status, but these factors have been compressed into three general categories:
- Behavioral Control: the type and level of control an employer has over how workers accomplish their tasks;
- Financial Control: the extent to which an employer controls the economic aspects of a workers job;
- Relationship of the Parties: the type of relationship between a worker and an employer, which is to be evaluated by certain factors such as the existence of a written contract, employee benefits, permanency of the relationship, and the types of services provided.
On the other hand, federal courts use a similar but distinct “economic realities” factor test to determine whether an individual is an “employer” under the Fair Labor Standards Act (“FLSA”). The Sixth Circuit applies six factors to consider in determining employment status: (1) the permanency of the relationship between the parties; (2) the degree of skill required for the rendering of services; (3) the worker’s investment in equipment or materials for the task; (4) the worker’s opportunity for profit or loss, depending upon their skill; (5) the degree of the alleged employer’s right to control the manner in which the work is performed; and (6) whether the service rendered is an integral part of the alleged employer’s business.
For employers, misclassification can be expensive and time consuming. Some important considerations employers should remember to avoid potential liability are:
- Avoid having an independent contractor do the exact same job as an employee and work that is integral to the business
- Do not micromanage the independent contractors work
- Always have a clear written agreements with independent contractors
- Do not give an independent contractor a job title
- Avoid exclusivity: independent contractors should not be restrained from working with other businesses
- Do not provide employee-type benefits to independent contractors
- Do not conduct performance reviews or evaluations with independent contractors
If you are an employer who uses independent contractors and have questions about an independent contractor or employee’s status, please reach out to request a consultation, or call us at 216-696-1422.
