Employee or Independent Contractor? A Question of Economic Realities

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From Aronson Beyond the NumbersJessica Taylor discusses the economic realities test for determining if a worker is an independent contractor or employee.  Jessica writes:

While independent contractors typically enjoy the benefits of a flexible arrangement, employers also benefit from fringe benefit costs. When a worker can be accurately classified as an independent contractor by the employer, they are precluded from certain benefits offered to full-time employees, such as health insurance, 401(k) plan participation, overtime, and paid time off. In addition to saving money from the aforementioned items, employers are also relieved of other employee-related responsibilities, such as state unemployment insurance, workers’ compensation, employer payroll taxes, and employee income tax withholding.

For employers, the difficulty does not lie in choosing the more optimal worker classification, but rather in ensuring that the facts of the arrangement fit the classification. It is imperative that employers classify workers appropriately and that the arrangement properly reflects that classification. The consequences of improper classification are becoming increasingly detrimental. Damages, back wages, and legal fees are multi-faceted due to IRS audits and employee civil suits, while there is still much to be desired in terms of transparency. While there is still no a cut-and-dry means of determining a worker’s true classification, the Department of Labor and the IRS have provided some guidance.

Central to classification determination is the economic reality of the arrangement, regardless of conflicting, formal agreement. An agreement to work as an independent contractor would be overridden if the agreement results in one that is essentially an employer-employee relationship. There are many signs that indicate an employer-employee relationship. Employers should ask themselves the following questions:

  • Is the work performed ongoing and integral to the core business?
  • Do I dictate where, when, and how the work should be done?
  • Do I limit the worker’s ability to perform for other clients?
  • Is the employee paid on an hourly basis or are their expenses reimbursed?

If employers answered “yes” to any of the above questions, there is a possibility that the arrangement would be considered employer-employee in nature. To safeguard from the ramifications of misclassification, employers should fully examine the nature of all worker arrangements and analyze the relationship from the perspective of an outsider. If after review, the classification is still unclear, the employer should file IRS form SS-8 “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” which will review the circumstances and offer an official classification.

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