Many companies employ independent contractors to supplement their workforce. By using independent contractors, businesses can minimize expenses from health insurance to payroll taxes to pension plans. These savings can provide much needed relief when the budget is balanced at the end of the year. Yet the distinction between independent contractors and employees can be vague and misleading, and a misclassification of workers could prove to be a costly mistake for employers.

The determination of whether a worker is an employee or an independent contractor is both a federal and state issue. Per the Federal Fair Labor Standards Act, an employment relationship must be differentiated from a strictly contractual one and, additionally, a U.S. Department of Labor (DOL) audit could uncover mistakes made in classification. Persons hired as independent contractors can dispute such classification and file for unemployment insurance if terminated or file for worker’s compensation if injured, triggering an audit. The DOL views misclassification as denying access to critical benefits and protections to employees, to which they are entitled by law. Employee misclassification also reduces taxes paid to federal and state governments, and lowers contributions to state unemployment insurance and workers’ compensation funds.

If a business is discovered to have improperly treated an employee as an independent contractor, the business will be held accountable for employment taxes for that worker, as well as unemployment insurance and workers’ compensation contributions, with associated fines and penalties.

In general, an independent contractor is an individual engaged in a business of his or her own, while an employee is dependent on the business he or she serves. The DOL’s Wage and Hour Division applies a six-factor balancing test, based on Supreme Court precedent, to determine a worker’s classification. These include: (1) the nature and degree of the potential employer’s control; (2) the permanency of the worker’s relationship with the potential employer; (3) the amount of the worker’s investment in facilities, equipment, or helpers; (4) the amount of skill, initiative, judgment, or foresight required for the worker’s services; (5) the worker’s opportunities for profit or loss; and (6) the extent of integration of the worker’s services into the potential employer’s business.

According to the New York State Department of Labor, independent contractors must be free from supervision, direction, and control in the performance of their duties. Furthermore, New York State is more stringent in determining whether an employer-employee relationship exists. An employer-employee relationship may exist (rather than an independent contractor relationship), if the employer: (1) chooses when, where, and how workers perform services; (2) provides facilities, equipment, tools, and supplies; (3) directly supervises the services; (4) sets the hours of work; (5) requires exclusive services; (6) sets the rate of pay; (7) requires attendance at meetings and/or training sessions; (8) asks for oral or written reports; (9) reserves the right to review and approve the work product; (10) evaluates job performance; (11) requires prior permission for absences; and (12) has the right to hire and fire.

All of these guidelines should be taken into consideration when businesses based in, or hiring from, New York State consider how to classify their workers.

The debate between contractors vs. employees has become extremely relevant in our modern economy where, in a study conducted by Intuit, more than 40% of American workers are predicted to be independent contractors by 2020. In a letter dated April 29, 2019, the DOL discussed this growing trend and concluded that workers who provide services through a specific company’s virtual marketplace platform should be classified as independent contractors. The DOL explained that the company in question only provided a platform through which to connect service providers with customers, and that they reject any employment relationship with the service providers. The DOL noted that service providers were obligated to provide their own certification of experience and qualifications before being allowed to use the platform, that the company did not provide any training, or even a required onboarding process, and allowed service providers immediate access to the platform. Thus, the DOL assessed that the service providers in this instance fell under the category of independent contractors, not employees.

Businesses that use independent contractors should conduct an internal audit every year or so, depending on the size of their business and how many independent contractors they claim, to make sure that all workers are properly classified. Please contact our office to discuss your specific business situation.