Employee versus Independent Contractor

Uber has recently garnered a lot of media attention for the way it classifies, and possibly misclassifies, its workers. The Company recently lost a case in the California Labor court for improperly classifying a driver as an independent contractor versus an employee, leading to a $4,000 settlement. Following this decision, the Department of Labor released a 15 page interpretation of its ruling that listed permanence and financial dependence as additional key factors in defining the worker/employer relationship. As Uber continues to battle a large class action lawsuit that could be a huge blow to its business model, the hot topic of employee versus independent contractor is gaining more public attention, and was even mentioned in the recent Presidential debates.

Why are they different?
There are many differences between independent contractors and employees. For the purposes of this article, we will focus on the most commonly recognized difference, which is tax treatment. Generally, employers must withhold income taxes from employees, pay Social Security and Medicare tax on employee wages, and pay unemployment insurance/tax as well. Independent contractors, on the other hand, do not have taxes withheld and are responsible for paying their own taxes.

Why is this issue so important?
It has been estimated that 20% of businesses misclassify workers, creating a significant lost revenue opportunity for Federal and State agencies. Employers can be held liable for the employment-related taxes for workers that have been misclassified, including both the employer and employee portions of Social Security and Medicare. Penalties, interest, and even criminal charges can also be levied against non-compliant employers. Combining all of those penalties has the potential to be a large financial blow to any company, but many Companies continue to misclassify workers based on faulty assumptions or a concern over the additional cost impact of proper classification.

How do I classify workers?
To determine whether a person is an independent contractor or an employee, an employer must typically consider four key areas:

1. Behavioral Control: Does the employer or the individual control when and how the work is done? Significant control by the Company may indicate that it should be an employment relationship.
2. Financial Control: Who provides work materials? Who controls how the work is paid and if any expenses are reimbursed? If there is no element of potential profit and loss on behalf of the contractor, this may be a red flag to the Department of Labor or other agency.
3. Relationship: Is there a written contract between the parties? Are benefits provided for the individual?
4. Permanency and Financial Dependence: Is the Relationship between the worker and the employer permanent and/or indefinite, versus for a limited duration? Is the individual worker’s income largely dependent on the Company? Any permanence or indefinite length in the relationship, or if the individual’s income is dependent on the job, the relationship is likely one of an employee.

As with most HR-related compliance areas, there is not a single factor that provides a clear cut indication of proper classification. All of the items above must be considered as a whole when making the determination. As a good general rule of thumb, an individual is an employee if the employer has the right to control what work is done, when it is done and how it is done. One could also point to the analogy that if it walks and talks like a duck, it’s probably a duck!

EctoHR suggests regularly reviewing your worker classifications to ensure individuals are being treated properly and to catch any instances where the classification may change during the term of the business relationship, based on business needs and/or changes in job duties.

Many clients rely on EctoHR to help audit and properly classify workers. For questions, please contact us at 810.534.0170 or hr@ectohr.com.