Classifying Workers as Employees and Independent Contractors

Classifying a worker as an employee or an independent contractor presents a number of challenges. Districts have a vested interest in making sure workers are appropriately classified because failure to do so may cost the district through unpaid taxes, back pay and benefits, fines, and penalties. We’ve provided information below 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 following points identified by the U.S. Supreme Court: 

• 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 Involvement

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.

It is important to establish if a worker is an employee or an independent contractor to determine the applicability of the Fair Labor Standards Act (FLSA). The provisions of the FLSA (e.g., requirement to classify an individual as exempt or nonexempt and pay overtime) apply to employees but not to independent contractors. Misclassification of exemption status may result in penalties for back pay and fines under the FLSA.

For purposes of FLSA compliance, the “economic reality” test is the one most commonly used [Doty v. Eddy’s Steakhouse, 733 F.2d 720 (10th Cir. 1984]. The economic reality test relies on the totality of the circumstances where no one factor is determinative. The economic reality test contends that an employee is one who is dependent on the business they serve, as distinguished from a person who is engaged in a business of their own. If the individual designated as an independent contractor doesn’t meet this test, they must be treated as an employee for FLSA purposes.

The FLSA rules apply the following six factors to analyze employee or independent contractor status:

• Opportunity for profit or loss depending on managerial skill
• Investments by the worker and the potential employer
• Degree of permanence of the work relationship
• Nature and degree of control
• Extent to which the work performed is an integral part of the potential employer’s business
• Skill and initiative

Detecting Misclassifications

While classifying workers appropriately can be challenging, some misclassifications are easier to detect. For example, if the district already has employees working in a particular job, other individuals hired to perform the same or similar duties should be considered employees, not independent contractors. Similarly, if a district hires individuals whose duties are an integral part of education, such as a counselor, diagnostician, or speech pathologist, they’re more likely to be considered employees and not independent contractors. Nor is an individual an independent contractor simply because the person works one or two days a week in one district and one or two days a week in another district (e.g., educational diagnosticians and speech pathologists).

More information about differentiating between employees and independent contractors is available in the DOL Wage and Hour Division Fact Sheet 13 and the HR Services Resource Library (see Independent Contractors).