DoL Updates Independent Contractor Classification

Say it with me: AI #2015-1. What is that, you ask? That’s the U. S. Department of Labor‘s (DoL) latest guidance on how to classify independent contractors (ICs). And if you’re a company who works with ICs, you’re not going to like this guidance any more than you liked the latest Fair Labor Standards Act (FLSA) update. This AI, or Administrator’s Interpretation, is a fuzzy one at best, and promises to cloud what had once been one of the most clear AIs. At worst, this AI promises to force some companies to reclassify some of their vendors from IC to EE (employee), and non-exempt EEs at that–meaning overtime-eligible.

As of July 15, 2015, the DoL narrowed the IC classification. As written, it looks as though more workers may be entitled to overtime and must be reclassified as employees. One portion of the AI is key, and that is the part that de-emphasizes the degree to which a business controls an individual’s work. Now, companies need to focus on the “economic realities test,” which reveals whether an individual is economically dependent on them or whether that person is truly in business for h/herself.

Classification Challenge

It’s no secret that many companies have mis-classified employees as ICs currently and in the past. This new guidance will at least force a re-evaluation of IC relationships so companies have an opportunity to get things straight. It will also force some new recordkeeping habits. For instance, now, at the beginning of a vendor relationship, business licenses should be shown, if not copied and kept in the vendor file, if vendors are to be paid on a 1099 basis.

The challenge for companies is the narrow focus on “economic dependence.” As written, the elements of the “economic realities test” seem understandable, but read carefully, you can see that there are no bright-line rules on which anyone can rely. The same person could be considered an IC or an EE simply based on the business at hand. The AI restricts the use of ICs to very few specific situations. No single factor listed in the AI can be relied on to tip the balance of classification one way or the other. As a result, executives (or even in-house counsels) will not always know what factor the DoL or a reviewing court will deem most important.

Economic Realities Test–Six Factors

The DoL has laid out six factors that need to be considered when conducting the economic realities test:

  1. The extent to which the work performed is an integral part of the company’s business.
  2. The vendor’s opportunity for profit or loss depending upon h/her managerial skills.
  3. The extent of the relative investments of the company and the vendor.
  4. Whether the work performed requires special skills and initiative.
  5. The permanency of the relationship.
  6. The degree of control exercised or retained by the company.

As guidance, the DoL writes, “In undertaking this analysis, each factor is examined and analyzed in relation to one another, and no single factor is determinative. The ‘control’ factor, for example, should not be given undue weight.”

“The factors should not be applied as a checklist,” the DoL continued, “but rather the outcome must be determined by a qualitative rather than a quantitative analysis.”

Qualitative rather than quantitative. What does that mean? It means you have to look at the task being performed and you have to ask yourself if what’s being performed is an employee function. Take, for example, a freelance carpenter who’s highly skilled. Say she has been contracted by a construction firm, but the carpenter does not independently exercise her skills. She doesn’t determine the sequence of work or order materials or think about bidding for the next job; rather, she is told what work to perform, where, and in what sequence. This carpenter, though highly skilled, is merely performing skilled labor. She isn’t thinking independently, and she’s not demonstrating the skill and initiative of an IC  (e.g. managerial or business skills). As such, she is an employee (and a non-exempt one at that).

In contrast, the DoL notes that “a highly skilled carpenter who provides a specialized service for a variety of construction companies (for example, custom, hand-crafted cabinets that are made-to-order) may be demonstrating the skill and initiative of an IC if the carpenter markets her services, determines when to order materials and the quantity of materials to order, and determines which orders to fill.”

Monitor Classifications

So, who should be responsible for monitoring the IC classifications? Human Resources? Finance? Executive secretary? Someone is going to have to own this issue. Moving forward, the DoL expects companies to make clear which department is responsible to understand the law, know which contractors have been engaged, and monitor compliance. Companies will have to maintain basic records based on the IC determination process, and the facts used to make the determination should be clear.

What should be kept on record? Copies of business licenses, business cards, tax records (1099s, not their filings), project work plans showing limited engagements, and correspondence from the contractor.

Key Points

  • The DoL believes most work should be performed by employees and IC should be used sparingly.
  • Entering into IC agreements or hiring a business entity (rather than a person) does not necessarily protect you from liability under the FLSA.
  • Before engaging the services of any non-employee, carefully review the type and scope of work to be performed.
  • When entering into agreements with other service providers, ensure that you obtain appropriate indemnification provisions to protect your company from wage-and-hour claims of service provider’s workers.

Other things to consider:

  • Avoid giving contractors rights or access that cut against contractor determination, e.g. internal e-mail accounts, server access, invitations to employee functions.
  • Periodically audit existing contractors to ensure they have not inadvertently become employees. (If an otherwise valid contractor arrangement becomes economically dependent on the work, then the relationship may convert to an employee entitled to overtime).

Disclaimer: I am not a licensed attorney. My blogs are based on my own experiences, interviews (where credited), and loads of research, and do not represent legal advice.

DoL Updates Independent Contractor Classification

Contract employee, independent contractor…(part 3 of 3)

When should I contract?

Well, if you know you want to have control over when and how work is done, as well as who does the work, then you should either hire an employee or do a temp-to-hire. Between the two, a temp-to-hire saves at least a contract’s worth of employment expenses, so if total cost is a factor, choose temp-to-hire, at least for non-managerial positions.

If you need to have specific skill sets and experience right away, a temp-to-hire is also less expensive if the contract is short enough. You have control over how work is done as well as a double-probationary period (the temp-time as well as your own period), which is plenty long enough to see if you have a good personality fit.

If you need a specific project completed that requires a specialized skill set not found in-house and not typically offered through an agency, then an independent contractor is the way to go. No employment costs, no unemployment costs, and you can terminate whenever you want for any reason.

Knowing the difference among these three classifications, should you ever have a government audit, can save your company thousands, if not millions, of dollars, and may even keep you in business. Many a company has felt the pinch of Uncle Sam to the tune of $10,000 as a flat fine for breaking the FLSA law and the additional $1000 for every other incident found during an audit.

For more information on different employee statuses, audits, and fines, speak to a local labor attorney or go on-line to & hour.

Disclaimer I am not a licensed attorney or certified accountant. My blogs are based on my own experiences, interviews (where credited), and loads of research.

Copyright © 2009 Diane Faulkner

Contract employee, independent contractor…(part 3 of 3)

Contract employee, independent contractor…there’s a difference? (Part 2 of 3)

Independent contractors have clients; temporaries and temp-to-perms do not

An independent contractor (IC) is independent of any other person or company than h/her own, which could be made up of one person, and is bound only by h/her own company’s policies and procedures, not yours. An IC seeks out work, negotiates contracts for work, is free to sub-contract work, sets the time schedule for work to be completed, is responsible for h/her own taxes, benefits, pension, and behavior. The contract between an IC and a company is solely for a result by a particular date, not, unless otherwise negotiated, for a particular person to perform work directed in any form by the client company.

The contract must be able to be terminated at any time and for any reason, or no reason at all, by either party. The IC must also be free to obtain other contracts – and work them – simultaneously. “Full-time” is not a phrase associated with an IC contract. Specified number of hours, hourly wage, salary, all these words imply “employee.”

In the former example, if I contracted an IC to be my credit union manager, I would not be able to do a background check or skills test. I would, of course, ask for and call on references to elicit the same type of information, but in the end, I don’t have the control to be any more thorough. If appropriate, though, I can ask for work samples. I can interview the person to determine fit, and I can also directly negotiate contract length and price. In short, I set my company up as the IC’s client.

The contract is everything

As a potential client, I need to think of everything I need and negotiate those needs into the contract. The key here is to be aware of contract law as applied to ICs under the Fair Labor Standards Act (FLSA). Unless there is some sort of regulating body that states a particular job must be done by a set procedure, I cannot write any procedure into a contract. If I do, then I create a regular employee under FLSA. Even if there is a particular person under the IC’s employ who has specialized skills necessary to complete the contract, I cannot write in who is to work the project. To do so creates an employee. An IC must be free to subcontract anyone s/he deems qualified to do the work.

Behavioral control

Where companies get into trouble working with an IC is control. Behavioral control of both the IC, but more so with its own employees, especially managers, who may not be schooled in working with a person who represents an entirely different company, but works alongside or for h/her.

The moment a manager has a counseling session with an IC is the moment the IC becomes an employee (EE). The moment a company requires an IC wear a particular outfit to represent the client company and not the contractor is the moment the IC becomes an EE. In the same vein, when a manager requests or demands a particular procedure from an IC solely because the procedure is customary or spelled out in the client company’s procedure manual, the IC becomes an EE.

But what if the IC is doing something wrong?

It is up to the client company to have a provision written into the contract that any of its employees can stop work on a contract project when it is apparent or suspected that an IC’s procedure will cause harm to a person, place, thing, or financially adversely affect the client company. Otherwise, the person who notices the potential harmful procedure must bring the person or matter to the attention to whomever is responsible for administering the contract, usually a top-level manager or a human resource contact, to make the IC stop work. At that time, the sub-contractor is to the IC for counseling or termination, or the client company can discuss the matter with the contracting IC or terminate the contract.

That’s actually the beauty of working with an IC: there doesn’t have to be any counseling, you can just terminate the contract and find someone else to complete the job, and you don’t have to worry about anyone filing unemployment credits against you.

And that’s the bad part of working with an IC: if you have to terminate a contract with a person with a special skill-set and experience level, it can be difficult to replace that person from within the company. You pretty much have to seek out another IC.

For more information on different employee statuses, audits, and fines, speak to a local labor attorney or go on-line to &  hour.

Disclaimer I am not a licensed attorney or certified accountant. My blogs are based on my own experiences, interviews (where credited), and loads of research.

Copyright © 2009 Diane Faulkner

Contract employee, independent contractor…there’s a difference? (Part 2 of 3)

Contract employee, independent contractor…there’s a difference? (Part 1 of 3)

Yes, there is. Knowing the difference can save you and your company a load of fines should you ever have a government audit.

The most basic difference is control. A contract employee (CE) is just that, an employee under contract. Employees are ,by the very definition, employed by the company for whom they perform a service. The contract between the employee and the employer can be short or long, by project, by expertise, by anything that is agreed upon by the two parties. A deal is struck, consideration is negotiated and paid, and at the end of the contract, renegotiation or termination occurs.

For a CE, renegotiation or termination is a key to keeping the person as contract and not an actual company employee. If the contract is written so that it is automatically renewed, then the ‘contract employee’ becomes a ‘regular employee’ and is due any benefits and status as any other person under traditional employ. The (now) employer is also responsible for all employment taxes…which is what the company wants to avoid.

Think temp-to-perm

The contract for the contract employee is held by the company to whom that person reports, which is not always the company for whom the person performs services. Manpower, Kelly, Accountemps, are familiar brand names to many. Temporary employees are under contract with a Manpower-type service and are sent out under contract to either a company that needs to fill a position and wants to “try out” a person’s skill sets or needs a particular short-term service performed, but doesn’t want to deal with negotiating a contract with a specialist.

Yes, there is a contract between a temporary and temp-to-perm company, but these contracts are for a percentage of wages paid over the course of an assignment (typically one percent of total gross wages). For example, say I need to fill a credit union manager position that has been temporarily vacated by a person going out on family medical leave (FMLA). I know my manager will be out for three full months beginning on a set date and returning on or about another set date. XYZ ManagerTemp agency has a slew of people registered in their databanks with not only managerial experience, but also with skills on our industry-specific computer system. The agency has already completed background checks and has W-2s on file.

When I call the agency, I let them know what I can pay and, though I have the option of just having someone sent over, I can also choose to have a selection scheduled for interviews. From the selection I choose, I can then see the skills-test results and written confirmation of the clear background checks. I choose the person, call the agency, and the person comes to work at my credit union.

Now, even though the temporary employee is under actual contract with the agency and must work under their policies, while performing for my credit union, that person must also work under our policies and follow our procedures. In other words, the agency does not control how the work is done, just the person’s schedule. Time off, tardiness, behavioral problems, all of these are handled by the agency. That is, if a temp needs to take time off for a personal matter, that person lets the agency know and the agency informs the credit union of the impending absence. Typically, the temp informs the position manager before the agency, but unless specified in that person’s contract with the agency or the agency’s contract with the credit union, the temp only needs to inform the agency. Either way, the credit union’s human resource contact is notified of the impending absence and is offered a fill-in or replacement at the same or reduced rate.

At the end of the contract, if I have need, or just want to, I can then negotiate to hire the temp in some capacity. I notify the agency of my intent and negotiate with the agency, not the temp, on the terms to buy out the contract. The agency officially contacts the temp with my intent to buy out, and the agency and temp work out acceptable terms, meaning the acceptable wage/salary-range. The agency contacts the credit union human resource contact, not the position manager, to negotiate a final number. If the contract employee accepts the number, the agency finalizes the deal, and the contract employee becomes a regular employee. If I have no more need for the person’s skills, the contract is ended.


— Come back Monday, January 30th, for part two of this three-part series.

For more information on different employee statuses, audits, and fines, speak to a local labor attorney or go on-line to &  hour.

Disclaimer I am not a licensed attorney or certified accountant. My blogs are based on my own experiences, interviews (where credited), and loads of research.

Copyright © 2009 Diane Faulkner

Contract employee, independent contractor…there’s a difference? (Part 1 of 3)

Are you really independent? (Independent Contractor vs. Employee status)

In the past two days, I’ve spent nearly eight hours talking to three different people about what makes them employees (EEs) rather than the independent contractors (ICs) they thought they were. Each person recently “lost contracts” through non-renewal.

Mind you I was at a golf tournament…which got me thinking. How many other people are in these folks’ situation? More than I realized, obviously, since I was being tapped during a tournament.

In listening to these folks I learned that each person was required to work on-site during the company’s business hours, use the ‘client’ company’s tools, receive performance reviews, work exclusively for the ‘client,’ and each had some sort of severance package after their ‘contracts’ were not renewed.

I was stunned. How could these employers not know they had employees and not Independent Contractors?

How to determine IC status

To be fair, determining the true status of an IC is tricky. In the current labor and economic markets, trending toward contractors rather than EEs seems – and many times is – a smart move for companies. No employment tax on an IC. No ding against retention/turnover rate post-contract. No increase in insurance, pension, or other EE benefit costs.

Problems arise when ERs start treating ICs like EEs…and many, if not most, ICs do not know when that behavioral line is crossed. Unfortunately, most ERs I have interviewed over the years – and I’ve been writing on labor issues for 11 years – are equally unfamiliar.

The behavioral line is a critical indicator of status
Just as the amount of control exercised by an ER over an exempt employee determines whether that employee stays exempt from the overtime rules, the right to control work processes determines whether or not an IC retains independent status.

The wrong behavior on the part of the contracting company can create an EE out of an IC.

To figure out if you have an IC relationship, I recommend a wonderful IRS form called an SS-8. It’s easy to use and can be downloaded from the site. This form should be filled out by ERs and ICs alike to determine if a true IC relationship has been established. I also recommend both parties download or request IRS Form 1779, which is a brochure updated in 2008 that clearly explains how the ER can get into trouble and what the IC is responsible for – to clients and, of course, to the IRS.

Rather than outlining all the common law factors that determine IC status, IRS Form 1779 three basic sections:
clarified and categorized them into

  1. Behavioral Control
  2. Financial Control
  3. Relationship Type

Be thankful, because following are the 20 Common Law Factors:

  1. Instructions
  2. Training
  3. Integration
  4. Service rendered personally
  5. Hiring, supervising, and paying assistants
  6. Continuing relationship
  7. Set hours of work
  8. Full-time work required
  9. Doing work on business owner’s premises
  10. Accomplishing work in certain order or sequence
  11. Submission of oral or written reports
  12. Method of payment
  13. Payment of business or traveling expenses
  14. Furnishing tools and equipment
  15. Significant investment
  16. Realization of profit or loss
  17. Work for one entity at a time
  18. Offer their services to the general public
  19. Right to discharge
  20. Right to terminate

Simple Example

I need to have my lawn cut once a week. I find a person who cuts lawns, negotiate a price for the season, and negotiate the start date with the end date set as the end of the season or first day of Fall.

  • Since there is an end date, there is no implied or expected contract continuation. If there were, then I would have just created an employment contract for a contingent employee and would then be responsible for all employment taxes. The employee would also be responsible for all my employee benefits, too.

That’s my contract. I need X service for Y amount of time at Z price and at W frequency. I define the work that needs to be done, the time frame in which it needs to be completed, and I negotiate the price I will pay. In this respect, I control the ‘what’ of work. (It’s the ‘what’ that I don’t want to do, which is why I’ve contracted someone else).

If the lawn person has quite a few contracts and needs to assign a different crew to do my lawn, I have no control over the people to send or the decision to assign. I do not control the ‘who’ of work.

  • No one on the crew, by the way, is critical to my project’s completion. I any were, I would need to have control over that person, which would make that person an EE.

The lawn person uses h/her own equipment to take care of my lawn. I do not control access to my equipment, even though I may have the same or similar equipment on my site. I do not supply electricity, gas, oil, electrical cords, lawn bags, rakes, wheelbarrows, fertilizer, seed, weed killer or other supplies and equipment, nor do I pay mileage or other expenses. I do not control the ‘tools’ of work.

The lawn person decides if it’s beneficial to do the back lawn first, then front, or maybe to do all the trim first and then start from front to back. I do not supervise or control the process of work. I do not control the ‘where’ of work.

The lawn person schedules my lawn cutting to work with h/her schedule and route. I do not control the ‘when’ of the work.

The lawn person uses h/her own techniques to complete the job and removes debris (or dumps it in my compost, whichever is negotiated). Either way, the essentials of work are taken care of by the lawn person, not me. I do not control the ‘how’ of work.

The lawn person sends me a bill for service. I do not pay any type of insurance – health, business, workers compensation or otherwise – for the lawn person. There are no bonuses to be earned, nor is there a severance paid after the contract terminates. The lawn person bears a significant financial risk in entering each contract and is responsible for paying crew, repairing tools, training, and covering crew under Workers’ Compensation.

The lawn service is available to more than just me. If I contract this person to do only my lawn, then I have myself an EE.

Who is an employee? 

The Internal Revenue Service uses these criteria to determine whether an individual is an employee or an independent contractor. The worker is an employee if…

  • You or your representative tells the worker where, when, and how to work.
  • You train the worker.
  • The business performance depends on the worker.
  • The worker has a continuing relationship with the company.
  • The worker’s services must be personally rendered by the him/her.
  • You set the worker’s work hours.
  • The worker works on the employer’s premises.
  • The worker is paid by the hour, weeks, or month.
  • You furnish tools and materials.
  • You can fire the worker without violating a contract.
  • The worker has a right to quit without incurring a liability.
  • The worker does not offer the worker’s services to the public at large.
  • The worker has no opportunity for profit or loss as a result of the worker’s service.
  • The worker has no significant investment in the business.
  • You require the worker to submit oral or written reports.
  • The worker is a key employee or corporate officer.

I hope I’ve helped you understand the difference between an EE and an IC. If you have any comments or questions, feel free to send them on.

If you’d like me to research another topic, let me know.

Thanks for checking my blog – and remember All Work Matters!


(c) 2009 Diane Faulkner

Disclaimer: I am not a licensed attorney or certified accountant. My blogs are based on my own experiences and loads of research.

Are you really independent? (Independent Contractor vs. Employee status)