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expand-collapse sectionWhat Is an Independent Contractor?
An independent contractor is a worker who individually contracts with an employer to provide specialized or requested services on a project or an as-needed basis. Employers frequently retain the services of independent contractors to assist them during peak business periods, to work on special assignments, and to perform services that are not part of the employer's regular business. There is really no single, absolute definition of an independent contractor. The important distinction, from the point of view of an employer, is that an independent contractor is an individual who is performing services for the employer but who is not an employee. Courts and government agencies generally examine the nature of the relationship between workers and employers to determine a particular individual's status. Independent contractor status is generally characterized by an “arm's length” relationship between the worker and employer. Depending on the particular law, courts have applied different tests for determining whether an individual is an employee or an independent contractor.
Independent contractors are not covered under numerous federal laws. Whether a worker is an employee or an independent contractor is critical when it comes to important issues such as pension eligibility, workers' compensation coverage, wage and hour law, and many other matters. Employers do not pay employment taxes for independent contractors and do not withhold federal, state, and local taxes from payments made to independent contractors. Also, independent contractors are not included in an employer's benefits programs, and they are not eligible for unemployment insurance benefits. Independent contractors are exempt from wage and hour and employment discrimination laws. Employers are not required to pay minimum wage and overtime to independent contractors.
expand-collapse sectionUpcoming Changes to the Independent Contractor Test
Effective March 11, 2024, the U.S. Department of Labor (DOL) will rescind its current independent contractor rule (2021 rule) and replace it with a new final rule that was published on January 10, 2024.
2021 Rule
The 2021 rule focuses on two core factors (bolded) and three remaining factors with less weight:
1. The nature and degree of control an employer had over a worker’s work;
2. The individual’s opportunity for profit or loss;
3. The degree of permanence of the work relationship;
4. The amount of skill and initiative; and
5. Whether work performed is integral to the employer’s business.
If the first two core factors lead to the same direction, then the analysis ends; however, if the first two core factors do not end in a clear result, then the remaining three factors are to be considered in order to determine the proper classification.
The 2021 rule was meant to be a more business-friendly approach to the independent contractor classification; however, due to administration changes, the 2021 rule was purported to be delayed. The new administration’s DOL then sought to rescind the 2021 rule entirely, but was met with legal challenges. A federal district court vacated the DOL’s attempted delay and withdrawal and the 2021 rule has remained in effect.
Instead of attempting to rescind the 2021 rule again, the current administration decided to replace the 2021 rule with its own new proposed rule, announced in October 2022.
New Rule
The new rule proposes to rescind the current 2021 rule and replace it with a six factor test that will return the analysis to a totality of the circumstances economic reality test. All factors are given equal weight:
1. The worker’s opportunity for profit or loss;
The following factors may be relevant in this determination: whether the worker determines or can meaningfully negotiate the charge or pay for the work provided; whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.
If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.
2. Investments by the worker and potential employer;
Costs to a worker of tools and equipment to perform a specific job, costs of workers' labor, and costs that the potential employer imposes unilaterally on the worker are not evidence of capital or entrepreneurial investment and indicate employee status.
If the investments are capital or entrepreneurial and serve a business-like function, such as increasing the worker's ability to do different types of or more work, reducing costs, or extending market reach, then this may suggest the worker is an independent contractor.
The DOL cautions against comparing worker investments and employer investments on a dollar or cost basis. The analysis should instead focus on whether the worker is making similar types of investments as the potential employer to suggest that the worker is operating independently.
3. The degree of permanence of the relationship;
If the work relationship is indefinite in duration or continuous, this would suggest that the worker is an employee.
If the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themselves, this would suggest that the worker is an independent contractor.
4. The nature and degree of the potential employer’s control over the work;
This also includes the consideration of “reserved control” or control the employer could exert, even if it does not.
The greater the degree of control over the worker, the greater likelihood of employee status.
Consider whether the employer sets the worker’s schedule, supervises the performance of the work, or explicitly limits the worker’s ability to work for others.
Also consider whether the employer controls economic aspects of the working relationship, including control over prices or rates for services and the marketing of the services or products provided by the worker.
5. Extent to which the work is “integral” to the potential employer’s business; and
If the work performed is critical, necessary, or central to the potential employer’s principal business, then this would suggest that the worker is an employee.
If a potential employer’s primary business is to make a product or provide a service, then the workers who are involved in making the product or providing the service are performing work that is integral to the potential employer’s business.
6. The worker’s skill or initiative.
This factor indicates employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work
However, the DOL notes that even where the worker brings specialized skills to the work relationship, this fact is not itself indicative of independent contractor status because both employees and independent contractors may be skilled workers.
“Other factors.” The factors in this test are not exhaustive and other factors may be relevant in a given case; however, the DOL only enumerated the six listed factors and did not suggest what those “other factors” may be. These “other factors” may be considered as long as they in some way indicate whether the worker is in business for themselves, as opposed to being economically dependent on the potential employer for work.
Legal Challenges
The lawsuit that resulted in a district court ruling enjoining the current administration’s DOL from delaying or rescinding the 2021 rule is still ongoing on in the 5th Circuit (see Coalition for Workforce Innovation et al. v. US Department of Labor; EDTX 1:21-CV-130). The court paused the lawsuit while the DOL drafted and published its final rule (new rule). It is likely that the court will remand the case to the Eastern District of Texas to consider the new rule.
expand-collapse section Various Independent Contractor Tests
The economic and tax advantages associated with the independent contractor relationship are significant. Therefore, the temptation to pursue and establish such agreements instead of permanent employment arrangements is a practical reality. In order to minimize intentional or inadvertent abuse that can result in substantial penalties, there are various guidelines to assist the employer in correctly identifying and classifying employment relationships.
Economic Realities Test
An employment relationship under the FLSA must be distinguished from a strictly contractual one. Such a relationship must exist for any provision of the FLSA to apply to any person engaged in work that may otherwise be subject to the Act. In the application of the FLSA, an employee, as distinguished from a person who is engaged in a business of his or her own, is one who, as a matter of economic reality, follows the usual path of an employee and is dependent on the business he or she serves. The employer-employee relationship under the FLSA is tested by "economic reality" rather than technical concepts. It is not determined by the common-law standards relating to master and servant.
The U.S. Supreme Court has, on a number of occasions, indicated that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation that controls. Among the factors the Court has considered significant are:
• The extent to which the services rendered are an integral part of the principal's business;
• The permanency of the relationship;
• The amount of the alleged contractor's investment in facilities and equipment;
• The nature and degree of control by the principal;
• The alleged contractor's opportunities for profit and loss;
• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor; and
• The degree of independent business organization and operation.
There are certain factors that are immaterial in determining whether there is an employment relationship. Such facts as the place where work is performed, the absence of a formal employment agreement, or whether an alleged independent contractor is licensed by state or local government are not considered to have a bearing on determinations as to whether there is an employment relationship. Additionally, the Supreme Court has held that the time or mode of pay does not control the determination of employee status.
The economic realities test has been used for the following laws:
• Title VII of the Civil Rights Act
• Age Discrimination in Employment Act
• Americans with Disabilities Act
• Fair Labor Standards Act
The U.S. Department of Labor (DOL) has said that the economic realities test should also be applied to the Family and Medical Leave Act, as well as the Migrant and Seasonal Agricultural Worker Protection Act.
Common-Law Test
The IRS utilizes a common-law test to classify workers. To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered. Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties.
1. Behavioral control. Facts that show whether the business has a right to direct and control how the worker performs his job functions include the type and degree of:
• Instructions that the business gives to the worker. An employee is generally subject to the business's instructions about when and where to do the work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, and what order or sequence to follow. The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right.
• Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors normally use their own methods.
2. Financial control. Facts that show whether the business has a right to control the business aspects of the worker's job include:
• The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform with their business.
• The extent of the worker's investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.
• The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. They often advertise, maintain a visible business location, and are available to work in the relevant market.
• How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
• The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.
3. Type of relationship. Facts that show the parties' type of relationship include:
• Written contracts describing the relationship the parties intended to create.
• Whether or not the business provides the worker with employee-type benefits such as insurance, a pension plan, vacation pay, or sick pay.
• The permanency of the relationship. If employers engage the worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the employer's intent was to create an employer-employee relationship.
• The extent to which services performed by the worker are a key aspect of the regular business of the company. If a workers provides services that are a key aspect of the employer's regular business activity, it is more likely that the employer will have the right to direct and control his or her activities.
Note: Be careful of the lure of past practice. Even though similar positions or the same position may have been classified as an employee or independent contractor in the past, working arrangements typically change over time. Therefore, be certain to evaluate the current status of the position in light of these factors.
The Internal Revenue Service (IRS)/common-law test has been used for the following laws:
• Federal Insurance Contributions Act (FICA)
• Federal Unemployment Tax Act
• Income tax withholding
• Employee Retirement and Income Security Act
• National Labor Relations Act
• Immigration Reform and Control Act
When in doubt about the status of a particular worker or class of workers, an employer or a worker may request an IRS determination preapproval by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. A Form SS-8 determination may be requested only to resolve federal tax matters. The party requesting a determination must file an income tax return for the years in question before a determination can be issued. A determination will not be issued for a tax year for which the statute of limitations on the tax return has expired. The statute of limitations expires 3 years from the due date of the tax return or the date filed, whichever is later. Although it can take at least 6 months to get a determination, a business that continually hires the same types of workers to perform particular services may want to file the Form SS-8.
Hybrid test. A hybrid test under which an employment relationship is evaluated under both common-law and economic reality test factors, with a focus on who has the right to control the means and manner of a worker’s performance, has been applied by courts to the following laws:
• Title VII of the Civil Rights Act
• Age Discrimination in Employment Act
• Americans with Disabilities Act
Reasonable Basis Test
The "reasonable basis" test provides a “safe harbor” to employers based on existing government or court classifications of workers in a particular business or industry and was mandated by the Revenue Act of 1978 (P.L. 95-600, Sec. 530), which provides that a worker may be appropriately classified as an independent contractor exempt from federal employment taxes if one or more of the following conditions are met:
• Judicial precedent treating workers in similar circumstances as nonemployees
• A Revenue Ruling issued by the IRS indicating that similar workers are exempt
• An IRS Technical Advice Memorandum stating that the worker in question is not an employee
• A long-standing and recognized practice in the industry of treating similar workers as nonemployees
• A prior IRS audit finding that individuals in substantially similar positions were not employees
ABC Test
ABC test. Numerous states, such as Massachusetts and California, have adopted the ABC test to classify workers as independent contractors or employees. The ABC test significantly toughens the analysis used to determine whether a worker can be classified as an independent contractor, and the change has had a big impact on gig economy workers. The test is putting stress on businesses such as rideshare giants Uber and Lyft because they and other gig economy entities rely on the independent contractor model, which is a far less expensive way to staff their businesses than hiring employees who are eligible to form unions, collect benefits, and be covered under an array of state and federal laws.
The ABC test presumes a worker is an employee unless the hiring entity proves the following:
A. The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact.
B. The worker performs work that is outside the usual course of the hiring entity’s business.
C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
expand-collapse sectionOther Legal Considerations
Statutes. Some workers who do not meet the reasonable basis, economic realities, or common-law tests for independent contractor status may still be classified as such by operation of law (i.e., statute). For example, licensed real estate agents who work under a written contract stating that they will be treated as nonemployees for federal tax purposes and who receive all of their income from real estate sales or related output (IRC Sec. 3508(b)(1)) will be considered nonemployees. Similarly, direct sellers meeting these same two conditions and who sell consumer products from a private home or as resale door to door will also be considered nonemployees (IRC Sec. 3508(b)(2)).
Contracts. Although in some cases the existence of a contract will lend support to an independent contractor classification, a contract may not, in and of itself, cure an otherwise inappropriately classified employer-employee relationship. Therefore, employers should be careful to avoid falling prey to such quick fixes.
expand-collapse sectionPenalties
Employers and workers may be subject to stiff criminal and civil penalties and fines if it is found that an employment relationship has been misclassified. Therefore, employers should be extremely cautious when classifying individuals as independent contractors.
Last updated on April 9, 2024.
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National
expand-collapse sectionWhat Is an Independent Contractor?
An independent contractor is a worker who individually contracts with an employer to provide specialized or requested services on a project or an as-needed basis. Employers frequently retain the services of independent contractors to assist them during peak business periods, to work on special assignments, and to perform services that are not part of the employer's regular business. There is really no single, absolute definition of an independent contractor. The important distinction, from the point of view of an employer, is that an independent contractor is an individual who is performing services for the employer but who is not an employee. Courts and government agencies generally examine the nature of the relationship between workers and employers to determine a particular individual's status. Independent contractor status is generally characterized by an “arm's length” relationship between the worker and employer. Depending on the particular law, courts have applied different tests for determining whether an individual is an employee or an independent contractor.
Independent contractors are not covered under numerous federal laws. Whether a worker is an employee or an independent contractor is critical when it comes to important issues such as pension eligibility, workers' compensation coverage, wage and hour law, and many other matters. Employers do not pay employment taxes for independent contractors and do not withhold federal, state, and local taxes from payments made to independent contractors. Also, independent contractors are not included in an employer's benefits programs, and they are not eligible for unemployment insurance benefits. Independent contractors are exempt from wage and hour and employment discrimination laws. Employers are not required to pay minimum wage and overtime to independent contractors.
expand-collapse sectionUpcoming Changes to the Independent Contractor Test
Effective March 11, 2024, the U.S. Department of Labor (DOL) will rescind its current independent contractor rule (2021 rule) and replace it with a new final rule that was published on January 10, 2024.
2021 Rule
The 2021 rule focuses on two core factors (bolded) and three remaining factors with less weight:
1. The nature and degree of control an employer had over a worker’s work;
2. The individual’s opportunity for profit or loss;
3. The degree of permanence of the work relationship;
4. The amount of skill and initiative; and
5. Whether work performed is integral to the employer’s business.
If the first two core factors lead to the same direction, then the analysis ends; however, if the first two core factors do not end in a clear result, then the remaining three factors are to be considered in order to determine the proper classification.
The 2021 rule was meant to be a more business-friendly approach to the independent contractor classification; however, due to administration changes, the 2021 rule was purported to be delayed. The new administration’s DOL then sought to rescind the 2021 rule entirely, but was met with legal challenges. A federal district court vacated the DOL’s attempted delay and withdrawal and the 2021 rule has remained in effect.
Instead of attempting to rescind the 2021 rule again, the current administration decided to replace the 2021 rule with its own new proposed rule, announced in October 2022.
New Rule
The new rule proposes to rescind the current 2021 rule and replace it with a six factor test that will return the analysis to a totality of the circumstances economic reality test. All factors are given equal weight:
1. The worker’s opportunity for profit or loss;
The following factors may be relevant in this determination: whether the worker determines or can meaningfully negotiate the charge or pay for the work provided; whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed; whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work; and whether the worker makes decisions to hire others, purchase materials and equipment, and/or rent space.
If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee.
2. Investments by the worker and potential employer;
Costs to a worker of tools and equipment to perform a specific job, costs of workers' labor, and costs that the potential employer imposes unilaterally on the worker are not evidence of capital or entrepreneurial investment and indicate employee status.
If the investments are capital or entrepreneurial and serve a business-like function, such as increasing the worker's ability to do different types of or more work, reducing costs, or extending market reach, then this may suggest the worker is an independent contractor.
The DOL cautions against comparing worker investments and employer investments on a dollar or cost basis. The analysis should instead focus on whether the worker is making similar types of investments as the potential employer to suggest that the worker is operating independently.
3. The degree of permanence of the relationship;
If the work relationship is indefinite in duration or continuous, this would suggest that the worker is an employee.
If the work relationship is definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themselves, this would suggest that the worker is an independent contractor.
4. The nature and degree of the potential employer’s control over the work;
This also includes the consideration of “reserved control” or control the employer could exert, even if it does not.
The greater the degree of control over the worker, the greater likelihood of employee status.
Consider whether the employer sets the worker’s schedule, supervises the performance of the work, or explicitly limits the worker’s ability to work for others.
Also consider whether the employer controls economic aspects of the working relationship, including control over prices or rates for services and the marketing of the services or products provided by the worker.
5. Extent to which the work is “integral” to the potential employer’s business; and
If the work performed is critical, necessary, or central to the potential employer’s principal business, then this would suggest that the worker is an employee.
If a potential employer’s primary business is to make a product or provide a service, then the workers who are involved in making the product or providing the service are performing work that is integral to the potential employer’s business.
6. The worker’s skill or initiative.
This factor indicates employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work
However, the DOL notes that even where the worker brings specialized skills to the work relationship, this fact is not itself indicative of independent contractor status because both employees and independent contractors may be skilled workers.
“Other factors.” The factors in this test are not exhaustive and other factors may be relevant in a given case; however, the DOL only enumerated the six listed factors and did not suggest what those “other factors” may be. These “other factors” may be considered as long as they in some way indicate whether the worker is in business for themselves, as opposed to being economically dependent on the potential employer for work.
Legal Challenges
The lawsuit that resulted in a district court ruling enjoining the current administration’s DOL from delaying or rescinding the 2021 rule is still ongoing on in the 5th Circuit (see Coalition for Workforce Innovation et al. v. US Department of Labor; EDTX 1:21-CV-130). The court paused the lawsuit while the DOL drafted and published its final rule (new rule). It is likely that the court will remand the case to the Eastern District of Texas to consider the new rule.
expand-collapse section Various Independent Contractor Tests
The economic and tax advantages associated with the independent contractor relationship are significant. Therefore, the temptation to pursue and establish such agreements instead of permanent employment arrangements is a practical reality. In order to minimize intentional or inadvertent abuse that can result in substantial penalties, there are various guidelines to assist the employer in correctly identifying and classifying employment relationships.
Economic Realities Test
An employment relationship under the FLSA must be distinguished from a strictly contractual one. Such a relationship must exist for any provision of the FLSA to apply to any person engaged in work that may otherwise be subject to the Act. In the application of the FLSA, an employee, as distinguished from a person who is engaged in a business of his or her own, is one who, as a matter of economic reality, follows the usual path of an employee and is dependent on the business he or she serves. The employer-employee relationship under the FLSA is tested by "economic reality" rather than technical concepts. It is not determined by the common-law standards relating to master and servant.
The U.S. Supreme Court has, on a number of occasions, indicated that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation that controls. Among the factors the Court has considered significant are:
• The extent to which the services rendered are an integral part of the principal's business;
• The permanency of the relationship;
• The amount of the alleged contractor's investment in facilities and equipment;
• The nature and degree of control by the principal;
• The alleged contractor's opportunities for profit and loss;
• The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor; and
• The degree of independent business organization and operation.
There are certain factors that are immaterial in determining whether there is an employment relationship. Such facts as the place where work is performed, the absence of a formal employment agreement, or whether an alleged independent contractor is licensed by state or local government are not considered to have a bearing on determinations as to whether there is an employment relationship. Additionally, the Supreme Court has held that the time or mode of pay does not control the determination of employee status.
The economic realities test has been used for the following laws:
• Title VII of the Civil Rights Act
• Age Discrimination in Employment Act
• Americans with Disabilities Act
• Fair Labor Standards Act
The U.S. Department of Labor (DOL) has said that the economic realities test should also be applied to the Family and Medical Leave Act, as well as the Migrant and Seasonal Agricultural Worker Protection Act.
Common-Law Test
The IRS utilizes a common-law test to classify workers. To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered. Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties.
1. Behavioral control. Facts that show whether the business has a right to direct and control how the worker performs his job functions include the type and degree of:
• Instructions that the business gives to the worker. An employee is generally subject to the business's instructions about when and where to do the work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, and what order or sequence to follow. The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right.
• Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors normally use their own methods.
2. Financial control. Facts that show whether the business has a right to control the business aspects of the worker's job include:
• The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform with their business.
• The extent of the worker's investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.
• The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. They often advertise, maintain a visible business location, and are available to work in the relevant market.
• How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.
• The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.
3. Type of relationship. Facts that show the parties' type of relationship include:
• Written contracts describing the relationship the parties intended to create.
• Whether or not the business provides the worker with employee-type benefits such as insurance, a pension plan, vacation pay, or sick pay.
• The permanency of the relationship. If employers engage the worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that the employer's intent was to create an employer-employee relationship.
• The extent to which services performed by the worker are a key aspect of the regular business of the company. If a workers provides services that are a key aspect of the employer's regular business activity, it is more likely that the employer will have the right to direct and control his or her activities.
Note: Be careful of the lure of past practice. Even though similar positions or the same position may have been classified as an employee or independent contractor in the past, working arrangements typically change over time. Therefore, be certain to evaluate the current status of the position in light of these factors.
The Internal Revenue Service (IRS)/common-law test has been used for the following laws:
• Federal Insurance Contributions Act (FICA)
• Federal Unemployment Tax Act
• Income tax withholding
• Employee Retirement and Income Security Act
• National Labor Relations Act
• Immigration Reform and Control Act
When in doubt about the status of a particular worker or class of workers, an employer or a worker may request an IRS determination preapproval by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. A Form SS-8 determination may be requested only to resolve federal tax matters. The party requesting a determination must file an income tax return for the years in question before a determination can be issued. A determination will not be issued for a tax year for which the statute of limitations on the tax return has expired. The statute of limitations expires 3 years from the due date of the tax return or the date filed, whichever is later. Although it can take at least 6 months to get a determination, a business that continually hires the same types of workers to perform particular services may want to file the Form SS-8.
Hybrid test. A hybrid test under which an employment relationship is evaluated under both common-law and economic reality test factors, with a focus on who has the right to control the means and manner of a worker’s performance, has been applied by courts to the following laws:
• Title VII of the Civil Rights Act
• Age Discrimination in Employment Act
• Americans with Disabilities Act
Reasonable Basis Test
The "reasonable basis" test provides a “safe harbor” to employers based on existing government or court classifications of workers in a particular business or industry and was mandated by the Revenue Act of 1978 (P.L. 95-600, Sec. 530), which provides that a worker may be appropriately classified as an independent contractor exempt from federal employment taxes if one or more of the following conditions are met:
• Judicial precedent treating workers in similar circumstances as nonemployees
• A Revenue Ruling issued by the IRS indicating that similar workers are exempt
• An IRS Technical Advice Memorandum stating that the worker in question is not an employee
• A long-standing and recognized practice in the industry of treating similar workers as nonemployees
• A prior IRS audit finding that individuals in substantially similar positions were not employees
ABC Test
ABC test. Numerous states, such as Massachusetts and California, have adopted the ABC test to classify workers as independent contractors or employees. The ABC test significantly toughens the analysis used to determine whether a worker can be classified as an independent contractor, and the change has had a big impact on gig economy workers. The test is putting stress on businesses such as rideshare giants Uber and Lyft because they and other gig economy entities rely on the independent contractor model, which is a far less expensive way to staff their businesses than hiring employees who are eligible to form unions, collect benefits, and be covered under an array of state and federal laws.
The ABC test presumes a worker is an employee unless the hiring entity proves the following:
A. The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of the work and in fact.
B. The worker performs work that is outside the usual course of the hiring entity’s business.
C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
expand-collapse sectionOther Legal Considerations
Statutes. Some workers who do not meet the reasonable basis, economic realities, or common-law tests for independent contractor status may still be classified as such by operation of law (i.e., statute). For example, licensed real estate agents who work under a written contract stating that they will be treated as nonemployees for federal tax purposes and who receive all of their income from real estate sales or related output (IRC Sec. 3508(b)(1)) will be considered nonemployees. Similarly, direct sellers meeting these same two conditions and who sell consumer products from a private home or as resale door to door will also be considered nonemployees (IRC Sec. 3508(b)(2)).
Contracts. Although in some cases the existence of a contract will lend support to an independent contractor classification, a contract may not, in and of itself, cure an otherwise inappropriately classified employer-employee relationship. Therefore, employers should be careful to avoid falling prey to such quick fixes.
expand-collapse sectionPenalties
Employers and workers may be subject to stiff criminal and civil penalties and fines if it is found that an employment relationship has been misclassified. Therefore, employers should be extremely cautious when classifying individuals as independent contractors.
Last updated on April 9, 2024.
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