In the world of contingent workforce management, the question of “what is an independent contractor” is perhaps one of the most basic and also the most difficult questions to answer. Many organizations are legitimately confused about how to properly classify individuals as independent contractors versus employees, and as a result expose their company to significant risk.
Unfortunately, for HR and Procurement practitioners who are charged with engaging contingent workers there is no clear answer as to whether an individual is an employee or independent contractor under the wage and hour law. This is partially because most federal and state agencies have different definitions and tests, but also because each standard is subjective and has an area of gray this is subject to interpretation or discretion depending on each unique case. In fact, there is no single “silver bullet” criterion or knock-out question to ask, but rather the compliance practitioner must gather all the evidence both for and against IC status, then make a defensible decision.
According to a recent US Department of Labor (DOL) bulletin, and many court cases, one key consideration is the “economic realities test.” This guideline asks whether a worker is legitimately in business for himself or herself (making them a genuine independent contractor) or are they economically dependent on the company engaging them for work (thereby making them an employee).
Courts evaluating independent contractor status must consider the economic realities test, and therefore review and analyze the totality of a variety of factors, including:
- What is the degree of direction and control exercised by the employer over the worker?
- Does the worker have an opportunity for profit or loss, and what is their investment in the business?
- What degree of skill and independent initiative is required to perform the work?
- What is the permanence or duration of the working relationship?
- What is the extent to which the work being performed by the worker is integral to the employer’s business?
What Should Companies Do?
Given this complexity, what should companies do? The most conservative approach would be to simply never use independent contractors. However, the reality of today’s talent scarcity environment, where many skilled knowledge workers want to be independent, does not make such an avoidance strategy feasible for most organizations. Another option is to offer all your contractors regular employment. However, this eliminates the flexibility that both companies and workers desire. For companies that are already using independent workers it does not make sense to just end engagements or attempt to convert independent workers to regular employees. Both of those approaches will likely have significant negative business implications.
As we saw earlier, there is no one-size-fits-all, definitive way to determine proper independent contractor classification. Fortunately, there are some practical steps you can take to help defend independent contractor status.
Written Independent Contractor Agreements
It’s an old legal principle that contract law does not supersede employment law. Simply stating that someone is an IC in an agreement will not necessarily make them one, but it does signal intent. The best approach is to craft an independent contractor agreement, a consulting agreement or a vendor agreement that defines the work to be done and the terms and conditions of the engagement including deliverables. You want to make sure to have and maintain arms-length written business agreement with each independent contractor that clarifies the scope of the relationship and explicitly defines areas where the contractor is expected to maintain significant amounts of control.
Just because you have a well-drafted contract does not mean you will prevail over the DOL or a state agency, or win a lawsuit challenging your classification. While a well-crafted IC agreement is not a magic wand that guarantees IC status, one thing is clear: if you do not have such an agreement in place it will be very difficult to argue that the worker in question was not an employee.
The Language We Use is Important
The language we use to describe an independent contractor working relationship is very important. A few examples:
- An independent contractor has a Bill Rate which defines how they are remunerated. As an independent “business of one” this should include all their self-employment burden and overhead expenses. An employee has a Pay Rate, where the employer has significant employer tax and benefits burdens.
- Never refer to your contractors as employees and don’t let them refer to you as their “supervisor” either in writing or verbally.
- “Employee” should never appear in your contractor agreements; it should not appear in policies you provide to independent contractors; nor should it be used in any emails.
- An independent contractor can’t be one of your corporate officers, and should not be supervising employees of the company.
- Independent contractors submit completed milestones or deliverables for payment, they should not submit a timecard for hours worked.
You Must Give Up Some Control
An independent contractor is exactly that – independent. The benefits of engaging an independent contractor comes with a tradeoff for the buyer — a true independent contractor is not your employee, and you cannot exercise the same degree of control over an independent contractor as you would over an employee.
What does this mean? Well, for example you should not:
- Provide them with the tools and equipment they need to do the job
- Set specific work hours
- Address poor performance via employee discipline forms or similar documents
- Ask contractors to supervise your regular employees
- Restrict your contractors’ ability to perform work for other businesses
This does not mean you have no say in terms of how and when the independent contractor performs their work. You just have to shift your mindset from buying time from an employee to buying deliverables or outcomes from the independent contractor.
Independent Contractors Are Not Employees, So Don’t Treat Them Equally
While written agreements and policy documents are helpful, a company engaging independent contractors also must ensure that its managers and other employees are aware of independent contractors’ status and do not treat such individuals the same as employees. For example:
- Do not invite independent contractors to office holiday parties and similar events
- Do not provide employee benefits to your independent contractors
- Do not invite independent contractors to your employee training sessions
Seek Help from Experts
As we’ve seen there are multiple laws, and federal and state government agencies who are concerned with proper worker classification. Independent contractor status determination is challenging and fraught with risk. Not only do the FLSA and federal tax laws come into play, but businesses must also worry about compliance with numerous state laws, including wage and hour enforcement, workers’ compensation, and unemployment insurance requirements. Each of these issues is complex and highly nuanced. The best course of action is have an expert, like TalentWave, on your side to make sure you evaluate and engage independent contractors the right way.
