Proper Classification of Employee vs. Independent Contractor

Many companies, particularly small and start-up businesses, use independent contractors to perform a variety of services during the company’s early stages. Use of independent contractors can help early-stage businesses (as well as seasoned companies) reduce or eliminate the cost of payroll taxes, unemployment insurance, worker’s compensation coverage, and benefits provided to regular W-2 employees. Independent contractors also allow for simpler bookkeeping and accounting, allowing companies to avoid the cost of implementing more complex accounting and payroll systems.

However, these benefits do not mean that employers should classify every worker as an “independent contractor.” Even the presence of a formal independent contractor or consulting agreement may not preclude a court from finding that an employment relationship exists. Courts apply an “economic reality test” to determine whether an employment relationship exists. The test examines 6 factors:

1. Is the relationship between the parties temporary or permanent?
2. Is a high level of skill required to perform the service?
3. Will the worker’s skill level effect his or her opportunity for profit or loss?
4. Which party is primarily responsible for providing the equipment or materials required to perform the services?
5. Does the “employer” have a right to control the manner in which the work is performed?
6. Is the “employee’s” service is an integral part of the “employer’s” business (i.e., which party is more dependent on the other?)

 Employers should review their relationships with consultants and other contractors through this “economic reality test.” A contractual agreement alone is not sufficient evidence to definitively classify a worker as an independent contractor. If an employee is improperly classified as an independent contractor, the employer may be liable for back pay, liquidated damages, civil damages, and attorney fees, or any combination of these remedies.