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Independent Contractors vs. Employees

In 2018 the laws surrounding contractors versus employees were more defined by the ABC test in California - but did you know this and other tests are also used by the Dept. of Labor? Misclassifying employees as independent contractors is a serious issue that could cost your company money. Learn the penalties you need to avoid.

Now I know my ABCs...

So, what is the ABC test? The ABC test was designed to help employers better understand how to properly classify employees and independent contractors. Under the ABC test, a worker is only an independent contractor if they meet and follow all three parts of the test.

  1. Control vs. Independence - The worker is free from the control and direction of their hirer in relation to the performance of the work, both in contract and in fact.

This means - if you want to dictate the hours someone works, what they wear, and the methods and tools they use, you're looking more at an employee. Independent Contractor's have the ability to determine their schedule, what uniform or clothing they wear, and how they complete a job task.

As an employer, you have the right to control your worker performance, results and means of how they accomplish those results. When you have a consultant, you don't have that control.

Example: You own a therapy business and require your therapists to use your company uniform, use your methods when practicing with clients, and set their specific hours of work. Since you as an employer are dictating the direction of their performance and work, they would be employees.

2. Independent Enterprise Business - The worker performs work that is outside the usual course of the hirer’s business.

This means - in order to be classified as a Contractor, the worker must be performing work that is not in the scope of the employing organization's business.

Example: A software company hires a consultant from EHR to handle HR tasks, and they do onboarding, handbooks, forms, and benefits. Since they are performing HR work, not the same course and scope of the software company, they are more independent Contractors.

3. Customarily Engaged - The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hirer.

Should have put a ring on it. When you're engaged, you're committed. As an employee, you're engaged to your employer, meaning you most likely only work for them. As a Contractor, you're not engaged to the employer, you're engaged in an independently established trade, so you're free to perform your services for other businesses as you see fit.

Example: A nail company hires nail technicians to work in the salon. The nail company provides the tools, training, and methods, and the technicians get paid by the hour and tips. They also can't work at any other nail salon due to a non-compete agreement. Since they're engaged to this employer and have to follow these business practices, they are most likely employees.


The Common Law Test

With the Common Law test (used by the IRS and some state agencies), 20 (twenty) factors are used to determine classification. Not all are used, but are a guideline for shaping the determination of the relationship. This tests focuses on control versus independence, with factors listed below.

  1. Instructions - the Employee is provided instructions from the company (when, where, how), the Contractor decides when, where, how.

  2. Training - Employee receives training from the company, Contractor receives little to no training (they bring the expertise).

  3. Services Rendered - Employee performs all assigned duties, Contractor is free to hire employees or 'subcontract' tasks.

  4. Set Hours - Employee works set hours by employer, Contractor sets their own hours.

  5. Profit or Loss - Employee receives pay for time and labor only (no additional gain or loss realized by the company) for services rendered, Contractor personally gains or loses economically based on services rendered.

  6. Time - Employee devotes employment to the business, Contractor doesn't necessarily work for just that one business.

  7. Order or Sequence - Employee performed services in order set by employer, Contractor decides sequence of work performed.

  8. Tools and Materials - Employee receives tools for job from employer, Contractor provides their own tools and materials to complete the job or tasks.

  9. Employer's Premises - Employee performs services at site of business, Contractor chooses where to perform services.

  10. Continuing Relationship - Employee has a continued relationship (non-sporadic) with the employer, the Contract performs 'projects' or 'services' and is free to move to other 'projects' as needed.

  11. Investment - Employee takes no investment in facilities or equipment, Contractor invests in facilities or equipment.

  12. More than One Business - Employee works only for employer (restricted), Contractor can provide services to multiple businesses at a time.

  13. Hiring - Employee may hire assistants only under employer, Contractor is free to hire and pay as necessary.

  14. Services Integrated - Employee services are integrated into the daily operational success of the business, Contractor services do not substantially affect overall success of business.

  15. Oral or Written reports - Employee submits reports to employer, Contractor is only accountable for the end results.

  16. Availability - Employer provides services to one business, Contractor offers services to general public.

  17. Payment - Employee paid by hour, week or month, Contractor is paid by project.

  18. Right to Fire - An employee maintains the discretion to discharge a worker, the Contractor may not be terminated as long as the performance proceeds according to terms.

  19. Business Expenses - Employee has expenses paid by the business, Contractor pays for their own expenses.

  20. Right to Quit - Employee can terminate relationship with business at any time, Contractor must fulfill contractual obligations.

Example 1: If you as an employer want a worker to use a specific method to complete a task, and wear a company uniform, they aren't in control of how they complete the job task, so they can't be defined as an independent contractor.

Example 2: You hire an HR Consultant from EHR for your business. You reach out to them for projects like employee handbooks, employment contracts, and trainings. Since the HR Consultant works during their schedule, wears their own uniform, and uses their tools and knowledge to complete the tasks, they are more likely independent contractors.


The Economic Reality Test

Used by the Department of Labor and some state agencies, the Economic Reality test looks at the employer-employee relationship, and determines if the worker is economically dependent on the business they're performing services for.

There are 5 (five) factors considered when determining work status:

  1. Degree of Control - The employer may control the employee, but not the independent contractor.

  2. Profit or Loss - The employee has no opportunity to profit from business gains or losses, the contractor gains or loses financially with the successes and failures.

  3. Investment in Facilities - The employee doesn't invest in the business's facilities, tools or equipment, the contractor is responsible for and does invest in their businesses tools, facilities or equipment.

  4. Permanency - An ongoing relationship happens with an employee, with a contractor, it's on a job by job basis (periodic or sporadic).

  5. Skill and Initiative - Employee skills further the activities of the employer, the contractor's skills are used to generate business opportunities in an open market, independent of the financial success of the particular business.


Your Job as an Employer

As an employer, you need to make sure you're classifying your workers correctly. A misclassification can be costly! Just because you create a document that the worker signs saying they're an independent contractor, doesn't mean it can hold up if the classifications are incorrect.

Having a dedicated HR professional can help you make these determinations appropriately, and ensure the proper documentation is in place and guidelines are followed.

Contact us with any questions!


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