Employee v Independent Contractor Classifications

Illumeo Customer Success's Profile

The determination of classifying a worker as an employee or an independent contractor has always been a manner of debate for many professionals.  While it would seem like that there should be a cut-and-dried system for making this determination, the reality is that the method of determination has always been slightly vague and confusing.  On Wednesday, January 6th, the US Department of Labor (DOL) issued a final ruling to explain the standard for determining whether a worker is an employee or an independent contractor.  This final ruling can be found under the Fair Labor Standards Act (FLSA).

Why is this final ruling important for accounting professionals?

Accounting professionals work in many industries, both public and private accounting.  All industries are subject to the DOL labor laws governing payroll, payroll taxes and benefits.  Whether an accounting professional is preparing taxes or providing tax advice or is working in a private industry classifying their employer’s workers as employees or independent contractors, it is imperative that the professional be abreast of the current ruling to ensure they do not face penalties and from the DOL.  Misclassification can result in serious fines and penalties.  

Why is the distinction between the two categories so important?

When a worker is classified as an employee, the employer must withhold payroll taxes from the employee’s pay as well as pay an employer portion of taxes on the employee.  By classifying a worker as an independent contractor, the employer is not required to collect and pay the payroll taxes and can simply issue the independent contractor a Form 1099 and the payment of taxes becomes the responsibility of the worker.  By classifying a worker as an independent contractor instead of a full-time employee, a company can save money on both taxes and benefits.  In recent years there has been an upward trend of classifying workers as independent contractors for this reason.

What are the testing methods for determining the correct classification?

  • Economic Reality Test:  the economic reality test is used to determine if a worker is in business for himself by generating his own work opportunities and therefore considered an independent contractor or if the worker is dependent on an employer for his work assignments and should be classified as an employee under the FLSA.  

  • Two Core Factors Test: this test provides some additional measures for review to ensure the determination made in the economic reality test is the best determination.  This first factor focuses on who has substantial control over key work aspects.  Factors to consider include a worker’s ability to select his own projects, set his own schedule, and figure out the best way to complete a job.  The second factor is reviewing the extent that a worker has the opportunity to earn profits or incur losses based on his own initiative and management of investments.  

  • If a definitive determination is still unknown, there are tie-breaking factors that can be reviewed for additional assistance.  Some of these factors are the amount of skill required for the work, the permanence of the position, and the integrality of the position as a part of the whole operation.

By issuing this final ruling, the DOL hopes to clarify the classifications and provide a higher level of certainty in the determinations.  It should also be noted that each state has its own laws for determining independent contractor status and some of the state laws are more detailed and stringent than the federal laws discussed here.