October 2016, Vol. 1

Employee or independent contractor?

Classifying a worker as an employee or an independent contractor presents a number of challenges. Districts have a vested interest in ensuring that workers are appropriately classified since failure to do so may be costly in terms of unpaid taxes, back pay and benefits, and penalties. The information below is provided as a guide to help districts avoid these costly mistakes.
 
Determining Independent Contractor Status
 
The determination of whether a worker is an independent contractor depends on the facts in each situation and must be analyzed on a case-by-case basis. To complicate the analysis, several Federal and State agencies have weighed in on the subject with their own guidance for classifying workers as employees or independent contractors. Although the definitions published by agencies are different, they all encompass the points identified by the U.S. Supreme Court that are described below.
 
The Court acknowledges that there is no single rule or test to determine if a worker is an employee or independent contractor. However, the Court has considered the following factors to be significant in making the decision:
  • The extent to which the services rendered are an integral part of the employer’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 organization
  • The alleged contractor’s opportunities for profit and loss
  • The amount of open market competition with others required for the success of the claimed independent contractor
 
Agency Cooperation
 
The Internal Revenue Service (IRS) and the Department of Labor (DOL) criteria for determining employment status and the potential for penalties imposed by these agencies are the most well-known. These agencies work together as part of the initiative to identify misclassified workers. The DOL also has a memorandum of understanding with the Texas Workforce Commission (TWC) to address employee misclassification. Other agencies, including Immigration and Customs Enforcement (ICE), Texas Department of Insurance (TDI), and the Teacher Retirement System (TRS), may become involved when a worker is misclassified.
 
Agency factors for classifying employees
 
The IRS common law factors for determining worker status as addressed in Publication 15-A include the following:
  • Behavioral—If the employer has the right to control when and where the work is done, the worker is probably an employee. The instructions given, including what tools or equipment to use, or what order or sequence to follow, are behavior control factors.
  • Financial—The opportunity for the worker to either make a profit or suffer a loss is an important factor in determining classification. Independent contractors generally have a significant investment in the equipment used to do a job, advertise their services, maintain a visible location, and are available to work for other employers.
  • Relationship—If the worker is hired with the expectation that the relationship will continue indefinitely, the worker is more than likely an employee. If the worker provides services that are key to the success of the business and his or her work is presented as that of the employer, the worker is more than likely an employee.
 
Factors such as having a signed agreement or the worker having an incorporated business are not sufficient in determining employee vs. independent contractor status.
 
On July 15, 2015, the DOL issued an Administrator’s Interpretation (AI-2015-1) applying the “economic realities” test to determine if a worker is an independent contractor. Under the Fair Labor Standards Act (FLSA), workers who are economically dependent on the employer are considered to be employees.
 
The Administrator’s Interpretation provides the following factors as guidance for determining if a worker is truly economically independent or dependent on the employer.
  • Is the work an integral part of the employer’s business?
    • If the work is part of the service the employer is in business to provide, the worker is more than likely an employee. For example, speech-language pathologists and accompanists for the choir do work that is an integral part of the services provided by a school district.
  • Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?
    • The worker’s managerial decisions related to their independent business such as bidding on work, renting space, hiring staff, and paying for advertising impacts the individual worker’s profit or loss beyond the current job, a factor that would support an independent contractor classification.
  • How does the worker’s relative investment compare to the employer’s investment?
    • A worker must make some amount of monetary investment and risk possible financial loss to be an independent contractor. Investment over and above the tools necessary to perform the specific job is an indication of an independent business.
  • Does the work performed require special skill or initiative?
    • The worker’s skill should be distinctly unique from the type of work performed by the employer and the worker should compete on the open market with others for business. The worker’s skill should prove the initiative and ability to exercise independent business judgement.
  • Is the relationship between the worker and the employer permanent or indefinite?
    • An ongoing work relationship with the district that continues from year-to-year suggests that the worker is an employee.
  • What is the nature and degree of the employer’s control?
    • This includes consideration of who sets pay amounts, who determines how the work is performed, and whether the worker is free to hire helpers. The DOL cautions that control should not play any greater role in determining status than any other factor.
 
More information about differentiating between employees and independent contractors is available in the DOL Wage and Hour Division Fact Sheet 13 and the Employment Section of the HR Library (see Independent Contractors).