Busting 4 Common Myths Around Employees and Independent Contractors

Posted August 6, 2018 by Miranda Geraci-Yee in Keeping Compliant
Many employers face confusion when it comes to classifying their workers as employees or independent contractors. In this post, we’re busting four common myths to help business owners get it right.

As we’ve covered on this blog before, there’s plenty of confusion from employers on how to classify their workers. Some of the most common questions arise from the nuances around employees and independent contractors.

It’s no small matter. Often enough, employees are misclassified as contractors — a critical mistake that state and federal government agencies take very seriously. Possible penalties are significant.

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A company that misclassifies employees as independent contractors may be liable for back pay (including overtime compensation), employee benefits, disability payments and workers’ comp, tax and insurance obligations, liquidated damages, and civil monetary penalties.

Still, several myths persist. Here, we bust the top myths about employees and independent contractors, and break down why they’re wrong.

MYTH #1: If a worker is an independent contractor under one law, they are an independent contractor under all laws.

There is no single test to evaluate independent contractor status for all purposes. As a general rule, companies should analyze the degree of control they have over the worker and the independence of the worker. Depending on the employment law at issue, a different test may apply to evaluate a worker's independent contractor status. It may be possible to be an independent contractor under one test and an employee under another!

Depending on the employment law at issue, a different test may apply to evaluate a worker's independent contractor status.

The Internal Revenue Service (IRS) uses the “control” test to determine whether an individual is an employee or independent contractor for federal tax purposes. The IRS test standard examines three aspects of the worker's control or independence: behavioral control, financial control, and the relationship of the parties.

In contrast, to assess independent contractor status under the Fair Labor Standards Act (FLSA), the federal Department of Labor (DOL) and courts use the “economic realities test.” The economic realities test focuses on whether the economic realities of the parties' relationship are such that the worker is dependent on the business to which they provide services. See DOL Fact Sheet #13, listing seven factors the U.S. Supreme Court considers significant in determining whether there is an employment relationship.

On top of that, many state agencies have their own tests to determine independent contractor status. Companies should ensure that their workers classified as independent contractors meet all applicable tests — not just one.

MYTH #2: You can engage someone as a contractor as a trial period, then hire them as an employee.

If you’ve believed this myth, you’re not alone. Plenty of companies think it’s perfectly okay to hire someone as an independent contractor for a few months as a trial period. If the person performs well, they’ll then bring them on as a full-fledged employee when the trial is up.

Sorry to say, but if you’ve done this, you may not have been following the law — particularly if the nature of the relationship and the work performed were the same during the trial period as they were when you hired the person as an employee.

Classifying someone as an independent contractor has nothing to do with time frame or trial period.

Classifying someone as an independent contractor has nothing to do with time frame or trial period. Classification depends on the facts of each case, application of the appropriate tests, and differences in the interpretation of those tests by courts and administrative agencies.

Filing a Form 1099 and Form W-2 for the same worker in the same taxable year could be a red flag for the IRS. When filing taxes, the individual will be reporting wages earned (on Form W-2) as well as earnings as a self-employed individual (on Form MISC-1099), which may invite scrutiny from the IRS or another government agency.

Related Article: Contractor or Vendor: How Do Businesses Classify for Correct Payment?

MYTH #3: It’s up to the worker whether they want to be an employee or a contractor.

You probably get the point by now, but the short answer here is no. The worker doesn’t get to choose their classification. However, this scenario comes up for many employers.

One common example is a worker who wants flexibility. Maybe they propose an arrangement that allows them to work from home and set their own hours, so they suggest working as an independent contractor.

Again, if the nature of the relationship falls under that of an employee-employer relationship under applicable tests, the worker should be classified as an employee. Of course that doesn’t bar you from creating flexible work arrangements with employees who want them! Developing a remote work or flexible policy with your employees is perfectly fine. It’s up to you as the employer to determine the best strategy for your team.

MYTH #4: If a worker signs an independent contractor agreement, they are an independent contractor.

An independent contractor agreement is not dispositive of independent contractor status. Many tests for independent contractor status generally give little weight to the parties’ characterization of the relationship, including in a written agreement. To put it another way, if your name is John and you put on a name tag that says “Judy,” it doesn’t make you a Judy!

Need help classifying your employees and independent contractors? Download the free guide.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.