Understand the difference so you can classify workers correctly.
Are you an employee or an independent contractor? If you are an employer, are you sure that you are properly classifying an employee or group of employees? If it is determined that you have incorrectly classified an employee as an independent contractor, not only will a back wage and tax contributions be required, but also substantial interest and penalties will apply, so getting it right is extremely important.
These classifications are instrumental for determining your legal obligations as an employer regarding workers’ compensation, unemployment insurance, wage and hour laws, and civil rights laws regarding hiring and other employment protections.
Merely stating in a contract that someone is or is not an employee is not sufficient; these individuals must in fact act as independent contractors, or your business will face significant risks.
This issue is made more complicated by the fact that the criteria for distinguishing between an employee and an independent contractor are different under different areas of the law. In fact, even under the same law, classification can vary based on the industry or your employer (e.g. special rules apply to the trucking and logging industries, and individuals working for government units and non-profit organizations).
Federal Law - Withholdings for Federal & State Income Taxes & FICA
Under federal law, employers are required to withhold from wages paid to employees amounts due for federal and state income taxes and one-half of social security taxes (FICA). In determining whether a worker is an employee or an independent contractor, the IRS typically focuses on the degree of control exercised by the employer over the worker in three primary functional areas:
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed and who provides tools, supplies, etc.)?
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Type of relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Fair Labor Standards Act - Overtime/Minimum Wage Provisions
In determining whether a worker is an employee or an independent contractor for purposes of the overtime/minimum wage provisions in the Fair Labor Standards Act, the courts have applied a six-factor test:
- What is the nature and degree of the employer’s control of the manner in which the work is to be performed?
- Does the worker have a real opportunity for profit or loss depending on the application of their managerial skill?
- Does the worker have a significant investment in equipment or materials in order to perform the work (or in hiring his own employees to perform the work)?
- Do the services performed require any special skills?
- Is the relationship between employer and the worker relatively permanent or of indefinite duration?
- Are the services being performed an integral part of the employer’s business?
Civil Rights - Wisconsin Fair Employment Act
The Wisconsin Fair Employment Act and cases determine whether a worker is an employee or independent contractor based on a list of factors, with the most important one being the employer’s right of control over the worker’s performance.
The most important factor is the employer’s right to control the means and manner of the worker’s performance. If you have some measure of control over the worker, it does not necessarily mean the worker is an employee. Nor does it mean that a worker with special skills is always an independent contractor. For example, a janitor may not have special skills but is still an independent contractor if he works for several companies under separate contracts and decides for himself how the work is to be performed. Obviously, the more control over the worker’s performance and conduct in the workplace, the more likely the individual is an employee.
In addition, there are eleven other factors a court must consider in order to determine whether a worker is an “employee”.
Workers’ Compensation Applicability
Wisconsin has a nine-point test for determining worker classification under the Wisconsin Workers’ Compensation statute. All of these must be satisfied or the worker is deemed an employee, and workers’ compensation obligations and benefits would apply. A worker is an independent contractor if he or she:
- Maintains a separate business–has a separate office space and have tools or equipment there that the worker owns; AND
- Has a Federal Employer Identification Number (FEIN) or has filed self-employment income tax returns in the previous year; AND
- Operates under contracts to perform specific services or work for specific amounts of money and under which the independent contractor controls the means of performing the services or work; AND
- Is responsible for own work expenses; AND
- Is responsible for satisfactory performance of contract and is liable for insufficient or nonperformance of the work; AND
- Receives payment per contract, or by job, commission or competitive bid; AND
- May realize a profit or a loss under the contract; AND
- Has recurring liabilities or obligations–these would occur regardless if the worker was not performing work for the employer such as office expenses or business insurance; AND
- Is in a position to succeed or fail if expenditures exceed income–no guarantee of compensation from employer without the possibility of experiencing a loss
Wisconsin Unemployment Compensation Act
Yet another test applies under the Wisconsin Unemployment Compensation Act (and even under this law, the test is different for individuals who provide services in the trucking or logging industry and individuals working for government units and non-profit organizations). Generally, a worker is excluded from the definition of an employee and will be considered an independent contractor if two separate conditions are met:
- The services are performed free from “control or direction” by the employing unit based on consideration of the following non-exclusive factors:
- Whether the individual is required to comply with instructions concerning how to perform the services;
- Whether the individual receives training from the employing unit with respect to the services performed;
- Whether the individual is required to personally perform the services;
- Whether the services of the individual are required to be performed at times or in a particular order or sequence established by the employing unit; and
- Whether the individual is required to make oral or written reports to the Employing unit on a regular basis; AND
- The individual meets 6 or more of the following 9 conditions:
- The individual advertises or otherwise affirmatively holds himself or herself out as being in business.
- The individual maintains his or her own office or performs most of the services in a facility or location chosen by the individual and uses his or her own equipment or materials in performing the services.
- The individual operates under multiple contracts with one or more employing units to perform specific services.
- The individual incurs the main expenses related to the services that he or she performs under contract.
- The individual is obligated to redo unsatisfactory work for no additional compensation or is subject to a monetary penalty for unsatisfactory work.
- The services performed by the individual do not directly relate to the employing unit retaining the services.
- The individual may realize a profit or suffer a loss under contracts to perform such services.
- The individual has recurring business liabilities or obligations.
- The individual is not economically dependent upon a particular employing unit with respect to the services being performed.
As you can see, each of these tests contains some factors that are similar, but there are significant differences between the tests depending on the context. There are a great number of factors to consider in properly classifying a worker. It is crucial that before hiring someone with the intent of giving them independent contractor status that you use the proper language in your employment contract and that you ensure that you do not exercise too much control over the worker’s performance. Further, be sure the worker has the other characteristics of separate and independent status as outlined above. Speak with a business law attorney if you have any further questions regarding employment law and classification.