Employment Law: Employee vs. Independent Contractor
In today’s ever-shifting economy, many job seekers are hesitant to ask too many questions during the interview process as they don’t want to risk losing an employment opportunity. However, job seekers may be doing themselves a disservice by not clarifying whether the position is as an employee or independent contractor. Whether the prospect will be considered an employee or independent contractor has numerous impacts on various important employment characteristics, including wages, taxes and withholdings, fringe benefits, behavior and relationships, schedules, and record keeping.
First, we need to define employee and independent contractor. Then, we can examine the important differences between the classifications and the ramifications that incorrect classifications can have on both the employer and employee.
Currently, the federal government has not established a comprehensive statutory scheme to distinguish between an employee and an independent contractor. Instead, different agencies define the distinction for their own purposes. According to the United States’ Small Business Association, an employee is defined as someone who “performs duties dictated or controlled by others; is given training for work to be done; and, works for only one employer.”[i] The National Labor Relations Act defines the term “employee” broadly. Instead of limiting the term “employee,” it includes anyone not excluded. People excluded as employees include agricultural laborers, those in domestic service of any family or person at his home, those employed by his or her parents or spouses and anyone with the status of an independent contractor.[ii]
An “independent contractor,” on the other hand, is someone who operates under a business name or under his own name, may have his own employees, may maintain a separate business checking account, may advertise his business' services, invoices for work completed, has more than one client, has his own tools and sets his own hours, and keeps business records. The IRS defines a person as an independent contractor “if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”[iii]
Some states have defined these terms and addressed the problematic overlap of definitions by providing guidance using a classification test.[iv] For example, in New Mexico, an individual is classified as an independent contractor if he meets all of the following standards:
(1) he provides labor or services free from direction and control over the means and manner of providing the labor or services,
(2) he obtains business registrations or licenses required by state law or local ordinance;
(3) he provides labor or services and furnishes the tools or equipment necessary to provide the labor or services;
(4) he retains the authority to hire and fire employees to perform the labor or services;
(5) he receives payment for labor or services…upon completion of the performance of specific portions of a project or is made on the basis of a periodic retainer; and
(6) he represents to the public that the labor or services are to be provided by an independently established business.[v]
Essentially, employees get paid for work under direct supervision of an employer, while independent contractors take on a job for a price, decide how the work will be done, and decide if it is necessary to hire others to help do the work.
There are many practical differences between employing an employee and employing an independent contractor.
The issue of withholding taxes is critical to the dichotomy. It is the responsibility of the employer to withhold an employee’s federal and state income taxes.[vi] The employer is also required pay the withheld taxes to the IRS and any applicable state agencies.[vii] People working as independent contractors, on the other hand, must pay their own income taxes and the employers (in most cases) need not withhold taxes.
Social Security and Unemployment
A second distinction between employees and independent contractors concerns Social Security and unemployment insurance. In most cases, employers are required to make payments into Social Security and unemployment insurance on behalf of employees.[viii] Independent contractors make their own contributions to Social Security.[ix] An employer also need not purchase unemployment insurance for independent contractors because the independent contractor is viewed as self-employed.[x]
Healthcare and Retirement Benefits
When employers offer certain retirement plans, those employers must make the retirement accounts available to all employees.[xi] Unlike employees, independent contractors are not due any sort of contribution toward a retirement plan or account.[xii] Other fringe benefits, such as health care coverage, vacation time, and sick leave are similar to retirement plans.[xiii] These benefits are available to employees under myriads of federal laws and regulations, but not to independent contractors.[xiv]
The current patchwork of laws across the United States makes it difficult for individuals and potential employers to differentiate between independent contractors and employees. Clarifying this confusion is important because of the harm mistakes may inflict on both workers and employers.
Some of the harms that can be caused by incorrect classification include:
· Employees may lose employment benefits such as health insurance, sick days, overtime, and retirement benefits if incorrectly classified
· Employees and prospective employees may lose protections afforded under occupational safety laws and anti-discrimination safeguards
· Competing businesses and taxpayers may be forced to pay, for example, emergency medical costs or welfare for uninsured employees who, by right, should have been covered under employer health insurance plans or unemployment insurance.
Misclassification also has legal punitive consequences for employers under both federal and state law. First, if an employer misclassified an individual as an independent contractor instead of employee the employer may be required to reimburse the employee for wages that should have been paid under the Fair Labor Standards Act, including overtime and minimum wage. Second, an employer will have to pay back taxes and penalties for federal and state income tax withholding that should have been paid to the government. Third, an employer can be required to make Social Security and Medicare payments that should have been made. Fourth, the employer will have to provide the incorrectly classified individual with employee benefits such as health insurance and retirement benefits.[xv] Finally, many states now impose criminal penalties such as jail time and fines upon a business that intentionally misclassifies an individual as an independent contractor.[xvi]
Although a job seeker may hesitate to do so, one issue that must be clarified in the hiring process is whether a prospective worker will become an employee or independent contractor. Once classified, it is extremely important to understand what that classification means in terms of pay, taxes, benefits, and scheduling. As technology continues to advance and more people are able to work on remote and per-project bases, more people find work that falls in the gray areas between employee and independent contractor. As such, knowledge of this area and understanding its importance is more important than ever.
[ii] 29 U.S.C.A. § 152(3)..
[iv] See Kan. Stat. Ann. § 44-766(a) (2011); N.J. Stat. Ann. § 34:20-4 (2007); Minn. Stat. Ann. § 181.723 (2014); N.M. Stat. Ann. § 60-13-3.1 (2005).
[v] N.M. Stat. Ann. § 60-13-3.1 (2005).
[vi] Lukens v. Goit, 430 P.2d 607 (Wyo. 1967).
[vii] Id. at 609.
[viii] See U.S. v. Polk, 550 F.2d 566 (9th Cir. 1977); Washington Recorder Pub. Co. v. Ernst, 91 P.2d 718 (Wash. 1939).
[x] See Taylor v. Horning, 38 N.W.2d 105 (Iowa 1949); Brewer v. Millich, 276 S.W.2d 12 (Ky. Ct. App. 1955).
[xi] Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 319 (2005).
[xii] Trustees of Resilient Floor Decorators Ins. Fund v. A & M Installations, Inc., 395 F.3d 244, 249 (6th Cir. 2005).
[xiii] See Nieves v. Univ. of Puerto Rico, 7 F.3d 270, 278-281 (1st Cir. 1993); Weber v. Comm'n of the Internal Revenue Serv., 60 F.3d 1104, 1113-1114 (4th Cir. 1995); Messer v. Dep't of Labor & Emp't Sec., 500 So. 2d 1372, 1373 (Fla. Dist. Ct. App. 1987).
[xvi] Julien Mundele, Not Everything That Glitters Is Gold, Misclassification of Employees: The Blurred Line Between Independent Contractors and Employees Under the Major Classification Tests, 20 Suffolk J. Trial & App. Adv. 253, (2015).