Independent Contractor Classification – Too Many Tests!

Over the last five years, employment law news has been filled with stories about companies paying millions in overtime back wages to independent contractors alleging they should have been treated as employees.

But, independent contracting is not a new business model. Many companies in many industries have been engaging independent contractors as part of their contingent workforce for decades. And, for decades, courts have been struggling to differentiate between an employee and an independent contractor. As the U.S. Supreme Court stated in 1944:

“Few problems in the law have given greater variety of application and conflict in results than the cases arising in the borderland between what is clearly an employer-employee relationship and what is clearly one of independent entrepreneurial dealing.”

NLRB v. Hearst Publications, Inc., 322 U.S. 111.

These words – “variety of application and conflict in results” – seem truer today than they were seven decades ago. So, why are we still struggling to define the line between employee and independent contractor?

The cause, at least in part, must be the number of different legal standards for determining whether a worker is an employee or an independent contractor. Under federal law, alone, there are three different tests: The 20-factor test used by the IRS; the six-factor “economic reality” test under the Fair Labor Standards Act; and the 12-factor Darden common law test for all other federal employment laws.

Layered on top of the federal standards is the state law. And, most states have different tests under different statutes – tax, workers compensation, unemployment, wage-hour and EEO statutes. Although some states use one or more of the federal balancing tests for some of its laws, most balance different factors or use some variant of a conjunctive “ABC” test. The ABC test, most commonly used under state unemployment insurance laws, which allows independent contractor status only if all of the following requirements must be met:

  • The contractor is free from control and direction by the company;
  • The services to be performed by the contractor are either outside the usual course of the company’s business or will be performed outside of the company’s place of business; and
  • The contractor is customarily engaged in an independently established trade, occupation, profession or business.

And, we can’t forget the states like Maine where a worker is presumed to be an employee under the state’s wage-hour, worker’s compensation and unemployment insurance laws unless all five of the following requirements are met:

  1. The person has the essential right to control the means and progress of the work except as to final results;
  2. The person is customarily engaged in an independently established trade, occupation, profession or business;
  3. The person has the opportunity for profit and loss because of the services being performed for the other individual or entity;
  4. The person hires and pays the person’s assistants, if any, and, to the extent such assistants are employees, supervises the details of the assistants’ work; and
  5. The person makes the person’s services available to some client or customer community even if the person’s right to do so is voluntarily not exercised or is temporarily restricted.

And, at least three of the following are met:

  1. The person has a substantive investment in the facilities, tools, instruments, materials and knowledge used by the person to complete the work;
  2. The person is not required to work exclusively for the other individual or entity;
  3. The person is responsible for satisfactory completion of the work and may be held contractually responsible for failure to complete the work;
  4. The parties have a contract that defines the relationship and gives contractual rights in the event the contract is terminated by the other individual or entity prior to completion of the work;
  5. Payment to the person is based on factors directly related to the work performed and not solely on the time expended by the person;
  6. The work is outside the usual course of business for which the service is performed; or
  7. The person has been determined to be an independent contractor by the federal Internal Revenue Service.

By my count, there are at least 80 different tests for independent contractor status under federal and state laws. Do you have a headache yet?

With all of the different factors considered under all of these different tests, determining whether to engage much-needed talent as an independent contractor or hire as an employee may be the most difficult compliance decisions that companies make. “Hire everyone as an employee!” – may be an easy and risk adverse approach, but often is just not practicable and not consistent with the needs of the business. The logic inside ComplianceHR’s Independent Contractor application applies every relevant factor in every relevant test, so you don’t have to.

Yes, I expect that litigation regarding independent contractor status will continue to increase. But, ComplianceHR can help you reduce the risk.