Independent Contractors

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Independent Contractors

Sections within this essay:

Background
Significance
Treatment of Independent Contractors Under Various Laws
Title VII Claims and the Economic Realities Test
Equal Pay Act and FLSA
Section 1981 Claims
Age Discrimination in Employment Act (ADEA)
Veterans' Reemployment Rights Act
Family and Medical Leave Act (FMLA)
Leased or Temporary Workers

Consequences for Improper Classifications
Summary of Significant Factors in Classification
Additional Resources
Organizations
Alabama Labor Department
Alaska Labor Department
Arizona Labor Division
Arkansas Labor Department
California Industrial Relations Department
Colorado Labor and Employment Department
Connecticut Labor Department
Delaware Labor Department
District of Columbia Human Rights Office
Florida Labor and Employment Security Department
Georgia Labor Department
Hawaii Labor and Industrial Relations Department
Idaho Labor and Industrial Services Department
Illinois Labor Department
Indiana Labor Department
Iowa Human Rights Department
Kansas Civil Rights Commission
Kentucky Labor Cabinet
Louisiana Labor Department
Maine Labor Department
Maryland Licensing and Regulation Department, Labor and Industry Division
Massachusetts Labor Executive Office
Michigan Labor Department
Minnesota Labor and Industry Department
Mississippi Employment Security Division
Missouri Labor and Industrial Relations Department
Montana Labor and Industry Department
Nebraska Labor Department
Nevada Labor Commission
New Hampshire Labor Department
New Jersey Labor Department
New Mexico Labor Department
New York Labor Department
North Carolina Labor Department
North Dakota Labor Department
Ohio Civil Rights Commission
Oklahoma Labor Department
Oregon Labor and Industries Bureau
Pennsylvania Labor and Industry Department
Rhode Island Labor Department
South Carolina Labor Department
South Dakota Labor Department
Tennessee Labor Department
Texas Employment Commission
Utah Commerce Department
Vermont Labor and Industry Department
Virginia Office of Economic Development
Washington Labor and Industries Department
West Virginia Commerce, Labor, and Environment Department
Wisconsin Industry Labor and Human Relations Department
Wyoming Labor and Statistics Department

Background

An independent contractor is a person who performs work or services for another person or company, for pay, but who is not employed by that person or company. The term itself is intended to convey the status of the individual as an independent worker who is a party to a contract for specific work (rather than a contract for employment), the performance of which is not controlled or supervised by the party requesting the service or work. As in any contract, there is no control of the physical conduct of the worker; only the end result (i.e., the fruit of the worker's labor) is accepted or rejected. For example, persons who hold themselves out as "consultants" are often retained by companies "independent contractors" who will provide expertise and assistance without actually being employed by the company requesting their expertise.

Significance

The distinction between employee and independent contractor is crucial in determining the application of several important federal and state laws, including those involving wages and withholding taxes, as well as such entitlements as eligibility for workers' compensation. Generally, when disputed, there is no single, dispositive test for government agencies to determine whether workers are independent contractors to a company, or employees thereof. Moreover, different criteria and legal tests are used for determining worker status, because each government agency is concerned with worker classification for a different reason. Accordingly, agencies may use their own independent worker classification criteria, without regard to what other agencies have done. By analogy, this is similar in application to that of a person who might be considered "disabled" for purposes of workers' compensation, but not for social security benefits. Also possible (but not common) is the result that a worker may be deemed an independent contractor in one state, but an employee in another.

Treatment of Independent Contractors Under Various Laws

Title VII Claims and the Economic Realities Test

Title VII [42 USC § 2000(e)] defines an "employer" as a person or entity who employs 15 or more employees in 20 or more calendar weeks in the current or preceding calendar year. The term "employee" is only loosely defined as "an individual employed by an employer." Importantly, Title VII prohibits discrimination by an employer against any individual "with respect to terms, conditions, and privileges of employment." Once a company or person reaches the status of "employer" under the statute, there may be liability exposure for claims that independent contractors were essentially functioning as employees and therefore entitled to the same privileges and conditions as employees.

Why is the distinction important if Title VII protects any individual, whether an employee or independent contractor? What is meant by the statutory provision is that an employer cannot choose to speciously label one worker as an employee and another as an independent contractor, for the purpose of paying one less than the other or providing less benefit coverage for one than the other, or otherwise illegally discriminate between them. If two workers are substantially performing the same work, for purposes of Title VII claims of discrimination, both will be deemed employees and the employer will be required to treat them equally in "terms, conditions, and privileges of employment."

In adjudicating such claims and controversies, courts often refer to what is known as the "economic realities" of the employment relationship to make a determination of status as applied to the facts presented. In applying an "economics reality test" to the situation before it, a court will review the employment relationship of the parties to see if the worker in question is actually functioning as an employee, because the worker performs most of his work for the employer and derives most of his income from the employer. Conversely, if the worker held himself and his services out to several companies, and derived his overall income from several of them, he might be more appropriately deemed an independent contractor.

Still, other courts find the economic realities test too superficial, and instead look to the common law for guidance. Under the common law standard, the primary emphasis is on a review of the degree of control and autonomy the worker has over his hours, methods used to complete the work, and materials used for the work. If the employer only looks to the end result, the worker is more likely an independent contractor. A milestone court decision on this matter was the case of Viscaino v. Microsoft Corp, (9th Circuit, 1997). Microsoft had routinely brought in outside "independent contractors" to work on various software programs. Microsoft needed their expertise, but made them sign contract agreements, in which they understood that they were not employees of Microsoft. Many of them worked several years in this capacity for Microsoft, and ultimately, a group of them filed suit under ERISA, hoping to recover lost pension and other benefits. Microsoft defended that these individuals were "independent contractors" and had accepted the work with that knowledge and understanding. The Court thought otherwise. It found that the workers had assigned desks, assigned phone numbers, and were otherwise treated essentially as Microsoft employees. In fact, the only difference was that they did not receive company-paid benefits. Microsoft lost the case.

Equal Pay Act and FLSA

Likewise, claims also may be brought under the Equal Pay Act [29 USC § 206(d)], which amends the Fair Labor Standards Act (FLSA). Generally, for wage/hour claims, the "economic realities test" in used in determining the true status of the worker. An example of this type of claim might involve an independent contractor who is to be paid a contract amount when the work is completed, but in reality, that amount is less than the minimum wage or does not account for applicable overtime pay. If the worker is deemed to be actually functioning as an employee, the employer may be liable for monetary damages.

Section 1981 Claims

The old Civil Rights law, passed during the post-Civil War era [42 USC § 1981] prohibits discrimination upon the basis of race in making and enforcing contracts. This has provided a cognizable cause of action for independent contractors involving their contractual relations with employers. (See Danco v. Wal-Mart Stores, 1st Circuit, 1999.)

Age Discrimination in Employment Act (ADEA)

Definitions found in the ADEA [29 USC § 621] are similar to those in Title VII, except that an "employer," for purposes of the ADEA, must employ 20 or more employees for each working day in 20 or more calendar weeks in the current or preceding calendar year. Likewise, protection against age discrimination by employers covers both employees and independent contractors.

Veterans' Reemployment Rights Act

Unlike Title VII and the ADEA, the Veterans' Reemployment Rights Act [38 USC § 4301] defines an employer as any person or entity "that pays salary or wages for work performed or that has control over employment opportunities." Under this Act, discrimination is prohibited against applicants as well as employees, due to their absence for service-related reasons.

Family and Medical Leave Act (FMLA)

Under the FMLA, an employer is defined as any person or entity that employs 50 or more employees for each working day in 20 or more calendar weeks in the current or preceding year. Eligibility for family leave is premised upon the completion of 1250 hours of service and a work status for at least 12 months. Because the FMLA incorporates FLSA definitions, the same rules would apply in determining worker status (the economic realities test).

Leased or Temporary Workers

Companies ("employers") also may be liable to temporary workers who are employed through third parties (such as personnel agencies). Case law holds that the personnel agency is generally deemed to be a nominal employer and the end-user company is the true employer. In the alternative, some jurisdictions have found that both are joint employers of the worker.

However, where an agency is merely leasing back employees to the company and has no meaningful contact with them, only the end-user will be found to be the employer.

Consequences for Improper Classifications

Employers are not required to withhold taxes from independent contractor earnings. Instead, they file information returns to the Internal Revenue Service and state authorities, indicating the amount paid in wages to the independent contractor. This information is also provided to the contractor on IRS Form 1099-MISC.

The Internal Revenue Code and various state laws impose substantial penalties on employers for improper classification of employees as independent contractors. Likewise, the Code imposes penalties and fines upon independent contractors who either fail to report income or who do not file self-employment quarterly returns. Additionally, the independent contractor will have to back-pay all taxes and social security deductions accrued during the misclassified period, in addition to those currently due.

Penalties to employers for failure to withhold income taxes are generally equal to 1.5 percent of the wages, plus 20 percent of the social security and medicare taxes that should have been paid by the employee. There is also a liability for the unpaid portion of the employer's portion of the social security and medicare taxes.

Summary of Significant Factors in Classification

In summary, the following factors are key in determining whether a worker is more correctly classified as an employee:

The worker can be terminated at will;
A manager (or designated person) assigns, reviews, and supervises the worker's work product.
The worker performs services that are a part of the regular operation of the business.