A Test for Determining Contractor Status

Is the person working for you a contractor or is he or she an employee? Does it really matter? The answer to the first question is not always clear, but the answer to the second question is an emphatic "yes!" Many employers understand that the law distinguishes between contractors and employees but

they do not understand the difference, nor do they understand how to apply the law to contractors once they have come onboard. However, the failure to classify contractors properly can cost employers millions of dollars.

Employees are directly hired by the company and are on the books and records of the company as "employees." Employers withhold taxes from employees' wages and pay certain payroll taxes on their behalf. Employers also must provide workers' compensation coverage and pay unemployment insurance taxes for employees.

Employees are usually entitled to receive various benefits, such as group health care, and are eligible to earn bonuses and participate in 401(k) plans and the like. Of course, depending on whether someone is a temporary, part-time, or full-time employee may make a difference in the amount or level of benefits received. But they are usually eligible for some or all of them.

But none of this applies to contractors. Contractors are not on the payroll. They work for themselves and are responsible for paying their own taxes. They are not eligible for employer-provided benefits and employers do not pay any payroll or unemployment compensation taxes on their behalf. The challenge, therefore, is in determining who is a contractor and then maintaining that status throughout the working relationship.

If someone is improperly classified as a contractor when, in fact, they should be considered an employee, the employer will be subject to substantial damages and penalties. For example, employers can be held responsible for overtime, retroactive employee benefits, various taxes (including the individual's tax liability), statutory penalties, etc. Microsoft learned this lesson the hard way and paid multimillions as the result of several class actions filed against it by contractors and temporary workers.

So how do you know whether a person is an employee or a contractor? Well, the line is not clear. But there are some guiding principles to keep in mind, taken from what is called the IRS 20 Factor Test. Other agencies at the federal and state level also publish contractor guidelines and it is possible that someone could be deemed a contractor for one purpose by one agency and not another. Also, there are common law tests that some courts have announced. But a good starting place is to understand and apply the IRS 20 Factor Test.

In summary, the main issues for contractor status are that the employer should not have the right to direct or control the work or the manner or method in which it is performed. Sound logical? Well, maybe not. But looking at some of the individual factors may help. For example, a contractor:

• retains discretion about where, when, and how to perform the job
• supplies their own tools and equipment
• performs work that requires a high level of skill or experience
• is engaged in his or her own distinct business
• performs work that is not a part of the regular business of the employer
• has the risk of making a profit or loss
• can solicit work and work for others during the contract assignment
• hires and pays their own assistants and other workers
• sets their own hours
• usually engages in short-term assignments
• cannot be directly discharged

As you can see, all of these elements are about the ability to control the worker and the manner and method in which the work is done. No one factor is determinative. In fact, in each case, some factors will be more important than others depending on the type of work, the size of the employer, the access to qualified workers, and the resources of the employer and contractor.

It is a good idea to design a process for onboarding contractors that incorporates the IRS test and any other tests that are important in your state and industry. And it is a good idea to write a clear contract that supports contractor status. Use staff members who are trained in understanding how to classify employees and contractors to review potential contracts and determine whether the assignments would pass muster under the legal tests.

Also, keep in mind that once the test is applied and the contract is signed, the "problem" of contractor status does not go away. Someone may be a contractor at the time of contracting but based on how the person is treated by the employer, a contractor can fast become an employee. That's because untrained supervisors may treat the person exactly as they would employees. Including the contractor in department meetings and office functions (onsite and offsite), department distribution lists, providing performance feedback and engaging in discipline, supplying business cards and materials, providing administrative support, and giving bonuses are just a few of the things that can be viewed as indicia of employee status.

It is possible to retain a contractor and maintain that status without making contractors feel isolated from the corporate culture. If you set expectations from the start about how the relationship will be handled once the contractor is onboard, and you treat the contractor with respect, you will have done a lot to help minimize the risk of being held liable for misclassification. And this is an area where employers are wise to risk the possibility that contractors may not feel fully embraced in the workplace in exchange for the peace of mind that any potential legal liability is minimized.

Consult with your human resources department and legal counsel to design the processes you need for your business. And once that is done, work with them to design training for your supervisors about the laws and regulations surrounding this issue. A supervisor who understands your contractor policies and how to treat contractors once they are onboard is a critical component of your risk management program.

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Note: This article does not constitute legal advice and should not be relied upon as legal advice. If you have a legal issue or wish to obtain legal advice, you should consult an attorney in your area concerning your particular situation and facts. Nothing presented on this site or in this article establishes or should be construed as establishing an attorney-client or confidential relationship between you and Barrie Gross. This article is provided only as general information, which may or may not reflect the most current legal developments or be complete.