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how to identify an independent contractor

What Is the New DOL Test to Identify Independent Contractors?

The Wage and Hour Division of the U.S. Department of Labor (DOL) released an administrator’s interpretation on July 15, 2015, containing their new guidance on how to identify someone as an independent contractor.

The new DOL independent contractor guidelines to determine a worker’s status could mean big changes for some businesses. Workers that are classified as independent contractors are filed with IRS Form 1099, do not receive overtime pay or benefits, and pay their own independent contractor taxes. Also, the employer does not withhold any taxes from the worker’s pay. Workers that are classified as employees are filed with Form W-2, can receive benefits and overtime pay, and have taxes withheld from their pay.

Independent contractor or employee?

Instead of the control test, an “economic realities” test should now be used to help employers determine if someone is an employee or an independent contractor. This new test is designed to help cut down on the number of misclassified workers. The economic realities test has six factors:

  • Is the work performed an integral part of the employer’s business? If the worker provides services that the company also provides, they are most likely an employee.
  • Does the worker have the opportunity for profit or loss depending on his or her managerial skill? A worker who can hire others or purchase supplies to increase their profit is most likely an independent contractor. If they can only increase profits by working overtime, they are probably an employee.
  • How does the worker’s investment compare to the employer’s investment? If the worker is making investments and taking risks to support business outside of a single job, they are typically a contractor. If the employer’s investment is significantly greater than the worker’s investment, the worker is probably an employee dependent on the employer.
  • Does the work performed require any special skills or initiative? If the worker needs any special business skills, judgement or initiative, they might be an independent contractor.
  • How permanent is the relationship between employer and the worker? If someone works long-term or repeatedly for an employer, the worker might be an employee.
  • How much control does the employer have over the worker? If the worker has significant control over meaningful aspects of the job, he or she is most likely a contractor.

When deciding someone’s employment status, employers should remember that no one factor can determine if someone is an independent contractor; all of the factors must be used and looked at together. The DOL is vague by not saying how many of the factors need to be met to classify a worker as an independent contractor, but they are strict if you classify a worker wrong.

Another important thing to consider is if the worker is in business for themselves. If the worker does not have their own business, they would most likely be W-2 employee.

For example, a cleaning company may have previously classified their workers as independent contractors by saying they had little control over how the cleaning was done. However, the workers are integral parts of the cleaning company, they have long term-relationships with the employer, and none of them rely on outside work or make investments in a personal business for an income. Under the new economic realities test, they would most likely be classified as W-2 employees.

Other things to consider when classifying an employee

Employers should keep documentation explaining how they determined someone to be an independent contractor. Things employers might want to include in this documentation are an analysis of the “economic realities” test, a description of the project the for which the worker was hired, and any communication with the worker. If the status of the worker is questioned later, the employer will have evidence of how they reached their decision.

If how to classify a worker is still unclear, either the worker or the employer can file IRS Form SS-8. By submitting this form, the IRS is asked to determine if the worker is an independent contractor vs. employee.

Misclassifying an employee can be serious. If someone is misclassified as an independent contractor, they will miss out on overtime pay and benefits. Federal, state and local governments also lose tax money. If it is discovered that someone was incorrectly identified as a contractor, the employer could owe back wages and back taxes.

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