The Wage and Hour Division of the U.S. Department of Labor (DOL) has created guidelines on how to determine whether a worker is an employee, or an independent contractor.
Independent contractors are workers that are classified with IRS Form 1099 and do not receive overtime pay or benefits; nor does the employer withhold any taxes from the worker’s pay. Employees file W-2 forms with the IRS, they can receive benefits and overtime pay, and have taxes withheld from their paychecks.
The DOL has created an “economic realities” test to help employers determine if someone is an employee or an independent contractor. The economic realities test has the following six factors:
1. Is the work performed an integral part of the employer’s business? The worker is probably an employee if s/he provides a service that the company also provides. A real independent contractor is unlikely to be integral part of the employer’s business.
2. Does the worker have the opportunity for profit or loss depending on managerial skill? A worker who can hire others or purchase supplies to increase profit is likely an independent contractor. Employees, on the other hand, can only increase profits by working overtime.
3. How does the worker’s investment compare to the employer’s investment? If the worker is making investments and taking risks to support a business, beyond a single job, that is a contractor. Comparing the worker’s investment to the employer’s investment helps determine whether the worker is an independent business. If the worker’s investment is quite miniscule, that indicates the worker and the employer are not even close to equal, that the worker is financially dependent on the employer, and thus, an employee.
4. Does the work performed require any special skills or initiative? If the worker requires special skills, business acumen, judgement or initiative, s/he could be an independent contractor. If the worker’s skills are performed at the direction of the employer, the worker is likely an employee. Even when those skills are highly specialized.
5. How permanent is the relationship between employer and the worker? If someone works long-term or repeatedly for an employer, the worker might be an employee. Even when the working relationship lasts only weeks or months, rather than years, there can be an indefinite quality to the relationship which lends itself to employee status. Independent contractors usually work on one project at a time, rather than continuously for an employer.
6. How much control does the employer have over the worker? When a worker works independently, that person is an independent contractor. Employees are, for the most part, under the control of an employer.
All of the above factors must be viewed together when deciding employment status; no one factor can determine status alone. The DOL does not dictate how many factors need to be met to classify a worker, but they are stringent when a worker is misclassified.
On a final note, if the worker does not have their own business, they would most likely be W-2 employee.
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