How new independent contractor standards affect your business

The Department of Labor (DOL) recently released a 15-page memo describing its standards for determining whether a worker is an employee or an independent contractor.

Worker classification affects whether businesses must provide overtime and other labor benefits, pay state and federal payroll taxes on wages paid to their workers, and offer healthcare under the "Affordable Care Act."

As a result, government agencies, including the DOL and IRS, are increasingly scrutinizing how businesses classify their workers.

What you need to know

Under the DOL’s new guidance, workers will not be treated as independent contractors simply because the business labels or treats the workers as contractors. Instead, the DOL will examine the “economic realities” to determine whether the worker is economically dependent on the employer —meaning the worker is an employee — or is truly in business for him or herself, which means the worker is an independent contractor. The DOL considers some of the following factors in making its determination:

Whether the individual’s work is an integral part of the business.

Whether the worker exercises managerial skills and has the ability to determine his or her profit and loss.

The extent of the worker’s investment in the business activity compared to that of the employer.

Whether the worker has the skills, initiative and judgment to operate an independent business.

The permanence and duration of the relationship.

The employer’s ability to control how the worker performs the job.

In applying these factors, the DOL takes a very broad and expansive view of who qualifies as an employee. Not surprisingly, the DOL concludes that most workers are employees and are entitled to federal labor law protection.

If the DOL audits a business and determines that workers are actually employees, the business may face overtime, back wages and numerous other claims from its workers. In addition, because the DOL shares information with the IRS and state agencies, the employer may be subject to examination by these agencies and incur liability for other past-due benefits, taxes and penalties.

Different standards

While the DOL uses “economic realities” to determine employment status, other government agencies apply different tests. For example, in determining whether an employer must pay federal employment taxes, the IRS focuses on the employer’s right to control or direct the worker.

State agencies often have their own tests for state unemployment and worker’s compensation laws. Because each agency has its own standards for determining who is an employee, it can be difficult and frustrating for a business trying to properly classify its workers and avoid the unfortunate and unpleasant consequences of misclassifying employees as independent contractors.

While many businesses attempt to classify workers as independent contractors in order to lower costs, they may discover that the practice can lead to some very costly results. As government agencies continue to scrutinize how businesses categorize their workers, employers should closely examine their worker classification to ensure that they comply with federal and state laws.