Worker classification is a critical issue for businesses, with significant legal and financial implications. Understanding the nuances of classifying workers as independent contractors or employees is essential to avoid costly mistakes. Recently, HumCap partnered with Ogletree Deakins to bring our community a valuable webinar on the topic. Read on for some key takeaways.

Independent Contractor Risk Analysis

Conducting a thorough risk analysis is vital. This involves understanding the specific roles and responsibilities of each worker and how they align with legal definitions. Misclassification can result in litigation, penalties, back taxes, back pay, and fines.

How do you do this?

We employ worker classification tests. Different tests are utilized to determine the correct status of a worker, ensuring compliance with labor laws. These tests vary by jurisdiction, reflecting differences in state and federal regulations. Complexity arises because each test has unique criteria, and the applicable test can change based on the location of the individual and specific legal issue at hand, such as wage and hour laws or unemployment benefits.

Key Tests for Identifying Worker Classification

  • ABC Test

This stringent test is often used by states like California and Massachusetts. To classify a worker as an Independent Contractor, It requires that the worker meets the criteria of the following three factors:

      1. Free from control and direction of the hiring entity
      2. Performs work outside the usual course of the hiring entity’s business or outside of all the places of business of the hiring entity
      3. Engaged in an independently established trade/occupation/business

*Certain states like California eliminate the clause, “outside of all the places of business”, making prong B even more difficult to satisfy.

  • Economic Realities Test

This test is more widely used, as it is enforced by the IRS and US DOL. This is a multi-factor test considering the totality of the worker’s circumstances. It evaluates factors such as the degree of control, opportunity for profit or loss, investments by the worker and the employer, skill and initiative, and whether the work is integral to the business. No single factor is determinative. This test is prevalent in Pennsylvania, Washington, and Virginia.

  • Right to Control Test

Focuses on the degree of control and independence, enforced by State Unemployment Agencies and often used by the IRS for federal tax purposes. The IRS looks at the right to control factors such as: behavioral, financial, and type of relationship. Other courts look at common law test, focusing on right to control. You see this test implemented in the following notable states: Texas, Florida, North Carolina, Ohio, Alabama, and Louisiana.

Common Mistakes and Best Practices

High Risk Mistakes:

  • Companies have a large percentage of workforce classified as Independent Contractors (IC’s)
  • No IC contract is signed with the contractor
  • Companies failing to update contracts regularly
  • Companies and/or contractors misunderstand the nature of the work relationship
  • Companies provide Independent Contractor’s with benefits
  • Companies assume industry norms apply universally

Medium Risk Mistakes:

  • HR handling IC issues in the same way that employee HR issues are handled
  • Companies lack of procedures to address performance issues with IC’s
  • Managers lack training on how to manage IC’s and any issues that may arise
  • Companies lack of procedures to engage IC’s

Best Practices for Independent Contractor Agreements:

  • Conduct regular audits to ensure compliance as you would with any other vendor
  • Maintain clear, updated contracts
  • Understand jurisdictional differences and apply the appropriate tests
  • Contractually declare IC status
  • Require fee and invoicing payments – not steady salary compensation
  • Permit contractors to work for others
  • Require contractors to pay their own expenses and taxes
  • Treat IC’s as a business partner, managed through procurement, finance, or operations

Navigating Legislative Changes

Employers must adapt to new rules and ensure compliance to avoid potential legal issues. Proactively performing regular internal audits is a recommended best practice.

The Role of Third-Party Expertise

Partnering with experts like HumCap can provide invaluable support in managing worker classification issues. We keep clients informed and effectively manage worker classification to protect them from potential pitfalls.

Learn More with HumCap

For a deeper dive into these topics, access HumCap’s full webinar recording featuring insights from Gavin Martinson, Labor and Employment Attorney, from Ogletree Deakins.

Contact HumCap for assistance and guidance on worker classification.