Independent Contractor 1099 OR Employee? How Do We Determine?

• Do a thorough classification analysis up front — before the relationship begins.
• Especially when you will have multiple people performing this type of IC work.
  • Liability on one misclassified IC is annoying.
  • Liability on 50, 100, 500, 1,000 misclassified ICs is devastating.

Three legal tests are used to make the Employee/IC determination.

IRS 20 Factor Test

Taxes (federal and state) & WC

• Instructions — Do we provide instructions on when, where, and how to do the work?
• Training — Do we train the worker?
• Services rendered personally — Cannot subcontract the work
• Hire, supervise, pay assistants — Is the IC allowed to have his/her own workers?
• Continuing relationship — Does the IC work for us during extended periods of time?
• Set Work Hours — Did we set those for them?
• Full Time Work — Are they working FT for us? Are they working exclusively for us?
• Order or sequence — Is the work required by us to be done in a specific order or sequence?
• Work on premise — Must the work be done on our company premise?
• Reports — Are regular/ongoing reporting by the IC required?
• Paid by the hour, week, month, or job?
• Expenses — Are we paying IC expenses?
• Tools and Materials — Did we furnish those?
• Does the IC have investment in the facilities where work is performed?
• Can the IC suffer a profit or loss on the job?
• Integration — Is the IC doing work integral to your business? VITAL
• Does the IC work for more than one company at a time?
• Does IC make their services available to the general public?
• Can company fire IC without liability?
• Can the IC quit without liability?

IRS 20 Factor Test — Main Issues

All 20 factors boil down to three main issues:

• Behavioral Control — Does the Company have the right to direct and control how the IC performs his/her services?
• Financial Control — Are the business aspects of the IC’s services controlled by the Company? (Pay, reimbursements, tools, and materials)
• Relationship of the Parties — As evidenced by written and oral agreements, duration of the relationship, employee benefits/health insurance, IC’s services are a critical part of the Company’s business

2 State Specific ABC Test

All workers are employees unless they satisfy all three of these conditions:

• The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact.
• The worker performs work that is outside the usual course of the hiring entity’s business.
• The worker is customarily engaged in an independently established trade, occupation, or business of the same nature of the work performed.

Revised DOL Economic Reality Test

To analyze if a worker is an employee or independent contractor, the final rule provides six factors that businesses and workers should consider when analyzing the economic realities of the working relationship. These factors, described in the economic reality test of the final rule, are:

• Opportunity for profit or loss depending on managerial skill.
• Investments by the worker and the potential employer
• Degree of permanence of the work relationship
• Nature and degree of control
• Extent to which the work performed is an integral part of the potential employer’s business.
• Skills and initiative

DOL Revised Economic Reality Test 2024

• No one factor or subset of factors determines if a worker is an employee or independent contractor.
• Rather, all the circumstances of the relationship should be examined.
• The weight given to each factor may depend on the facts and circumstances of the particular relationship.
• Also, additional factors may be relevant if they in some way indicate if the worker is in business for themself as opposed to being economically dependent on the employer for work.

Factor 1: Opportunity for Profit/Loss

Does the worker have opportunities for profit or loss based on managerial skill that affect the worker’s economic success or failure?

Managerial skills can include initiative or business expertise or judgment. The following facts, among others, can be relevant in the determination:

• Whether the worker determines or can meaningfully negotiate the charge or pay for the work provided
• Whether the worker accepts or declines jobs or chooses the order and/or time in which the jobs are performed
• Whether the worker engages in marketing, advertising, or other efforts to expand their business or secure more work.
• Whether the worker makes decisions to hire others, purchase materials, and equipment, and/or rent space.

If a worker has no opportunity for a profit or loss, then this factor suggests that the worker is an employee. Some decisions by a worker that can affect the amount of pay that a worker receives, such as the decision to work more hours or take more jobs when paid a fixed rate per hour or per job, generally do not reflect the exercise of managerial skill indicating independent contractor status under this factor.

Factor 2: Investments by Worker and Employer

Are any investments by a worker capital or entrepreneurial in nature? The following facts, among others, can be relevant in that determination:

• Costs to a worker of tools for a specific job and costs that the employer imposes on the worker are not capital or entrepreneurial investments that indicate independent contractor status. Investments that are capital or entrepreneurial in nature and indicate independent contractor status generally support an independent business and serve a business-like function, such as increasing the worker’s ability to do different types of or more work, reducing costs, or extending market reach.
• Additionally, the workers’ investments should be considered on a relative basis with the potential employer’s investments in its overall business. The worker’s investments do not have to be equal to the potential employer’s investments and should not be compared only in terms of the dollar values of the investments.
• The focus should be on whether the worker makes similar types of investments as the employer (even if on a smaller scale) or investments of the type that would allow the worker to operate independently in the worker’s industry or field. Such investments by the worker in comparison to the employer weigh in favor of independent contractor status, while a lack of investments that support an independent business indicate employee status.

Factor 3: Degree of Permanence of the Relationship

Is the work relationship indefinite in duration, continuous, or exclusive of work for other employers? That would weigh in favor of the worker being an employee. Is the work relationship definite in duration, non-exclusive, project-based, or sporadic based on the worker being in business for themself and marketing their services or labor to multiple businesses? That would weigh in favor of the worker being an independent contractor.

• This may include regularly occurring fixed periods of work, although the seasonal or temporary nature of work by itself would not necessarily indicate independent contractor classification.
• Where an individual cannot perform work on a permanent basis due to operational characteristics that are unique or intrinsic to particular businesses or industries and the workers they employ, then this factor would not necessarily indicate independent contractor status unless the worker is exercising their own independent business initiative.

Factor 4: Nature and Degree of Control

Does the potential employer have control, including reserved control over the performance of the work and the economic aspects of the working relationship? Reserved control means the employer has the right to control even if they do not actually exercise the control. An example of reserved control is if an employer reserves the right to discipline a worker for declining a job.

Relevant facts, among others, may include whether the potential employer:

• Sets the worker’s schedule
• Supervises the performance of the work
• Explicitly limits the worker’s ability to work for others
• Uses technological means to supervise the performance of the work (such as by means of a device or electronically)
• Reserves the right to supervise or discipline workers
• Controls economic aspects of the working relationship, such as the prices or rates for services and the marketing of the services or products provided by the worker

Factor 5: Work Integral to the Employer’s Business

Is the work performed an integral part of the potential employer’s business?

• If the work performed by a worker is critical, necessary, or central to the potential employer’s principal business, then this factor indicates that the worker is an employee.
• If the work performed by a worker is not critical, necessary, or central to the potential employer’s principal business, then this factor indicates that the worker is an independent contractor.

This factor does not depend on whether any individual worker is an integral part of the business, but rather whether the function they perform is an integral part of the business.

Factor 6: Skill and Initiative

Does the worker use specialized skills to perform the work and do those skills contribute to business-like initiative?

• This factor indicates employee status where the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work.
• Where the worker brings specialized skills to the work relationship, this fact is not itself indicative of independent contractor status because both employees and independent contractors may be skilled workers. It is the worker’s use of those specialized skills in connection with business-like initiative that indicates that the worker is an independent contractor.

Employee Misclassification and Potential Liability

• When individual workers or groups of workers are incorrectly classified as ICs (1099-MISC) when they should have been classified as employees (W-2)
• Misclassification can lead to substantial liability for employers.
• Uber — $100 million to the NJ Unemployment Trust Fund for misclassified drivers (9/13/22)
• PL Construction — $246,000 to the USDOL for misclassified painters (8/4/22)

Misclassification — Employment Tax Problems

• FICA (SS and Medicare) — Employer and employee each pay 6.2% (SS) + 1.45% (Medicare)
• FUTA — 6% of the first $7,000
• State Unemployment Insurance — SUI tax rate on the first $9,500.
• Example: IC — $70,000/year
  • FICA = $4,340 + $1,015 = $5,355
  • FUTA = $420
  • SUI = 6.0% x $9,500 = $570
  • Total = $6,345/tax year + penalties + interest
    • What if (a) Multiple tax years; and (b) You have 50 ICs just like this one

Misclassification — Minimum Wage and Overtime Problems

• State and federal law require employees to be paid at least minimum wage for all hours worked and overtime for all hours worked over 40 in a week.
• Employers must track hours worked, pay a proper wage, and accurately calculate overtime.
• Workers classified as independent contractors often get paid on a project basis, don’t track their hours worked, and don’t pay attention to minimum wage and overtime.

Possible Costs and Damages

• Back wages
• Unpaid overtime (at overtime premium)
• Liquidated damages
• Civil penalties
• Attorney’s fees and costs
• Individual liability

Minimum Wage and Overtime Example — Direct Care Workers

Workers Compensation Problems

• Company does not have WC insurance (all workers are ICs)
• Company is liable for WC or tort damages.
• Directors and officers of the Company are personally liable for all damages.
• You do have WC insurance for Company’s W-2 employees.
• Carrier will deny coverage for injured ICs — can result in tort lawsuits.
• Yearly WC premium audits — WC insurance carriers audit your payroll records on a yearly basis, and they can charge you additional premiums on ICs.

• Georgia Home Care Workers Compensation Insurance
• North Carolina Home Care Insurance

Best Practices to Negate Liability

• Clearly establish the relationship up front — before any work is performed — how they will be paid, how taxes will be handled, etc.
• Avoid having ICs performing the primary/integral functions of your company.
  • Best practice: Hire these individuals as employees of your company.