Whether a business classifies someone as an independent contractor or an employee can have far-reaching effects in a large number of fields: workers’ compensation, taxation, liability insurance, health care, unemployment insurance etc. A company can gain many benefits from classifying someone as an independent contractor. However, misclassifying someone as an independent contractor can lead to severe penalties with the IRS, Department of Labor and other organizations.
So how does the government define an independent contractor? Scott Nuelle, Vice President, a consultant at ECBM, points out, “Like many issues, the answer depends on which state or governmental entity when answering the question. The IRS has one definition, but many states have different definitions developed through common law or state agencies. This can put companies in potentially dangerous situations. Someone who the IRS considers an independent contractor might qualify as an employee in New Jersey.”
For the IRS, the key definition comes down to control. The more control the payor has, the less likely a person is an independent contractor and the more likely that person is an employee. Kevin Forbes, Vice President a transportation specialist at ECBM, states, “If the payor can only control or direct the result of the work, but not how it will be done or what will be done, then the person qualifies as an independent contractor. The more independent the person doing the work, the less likely they qualify as an employee.” Additional factors to consider include the extent to which employee-type benefits exist, whether expenses are reimbursed, who sets and controls the hours of work, and who provides tools and supplies.
Several courts have also interpreted the Fair Labor Standards Act to require an “economic realities test” in determining independent contractor status. This tests asks to what extent the individual is financially dependent on the business and looks at factors such as the employee’s level of skill, the nature of the work requested and how it relates to the focal point of the business, the intent of the parties and other additional factors.
However, several states, including New Jersey and New York, employ a significantly stricter test in determining whether a person qualifies for independent contractor status. New Jersey uses what is called the ABC test. Under the ABC test, a person qualifies as an employees unless the employer demonstrates that:
A. the employer does not exercise control over the worker and does have the ability to exercise control in terms of the completion of the work;
B. the services provided are outside the usual course of business or performed outside of all the places of businesses of the employer; and
C. the worker has a profession that will plainly persist despite termination of the challenged relationship.
In Pennsylvania, it is also important to be able to show that the Company does not wield over the daily operations of the Independent Contractor. And always avoid any employment terminology.
Companies seeking to hire independent contractors in lieu of employees must educate themselves on both the federal tests for determining independent contractor status and the state tests in any locations in which they operate.