Knowing whether a worker is an employee or an independent contractor is important for both workers and employers. Any worker should understand how they are classified. As an independent contractor, you may have more freedom to choose how you complete your work, but you are responsible for paying your own taxes, getting your own health insurance, and paying into unemployment and workers comp funds if you wish to access those benefits.
If you are an employee you are under the control of your employer, but you may also have certain benefits provided by your employer like workers compensation, unemployment, and health insurance. Employers must be careful to make sure that workers are properly classified because a worker’s title does not determine whether they are an employee or independent contractor. It is the nature of the relationship that matters, and employers can be subject to stiff penalties if they misclassify workers. To find out more about what an independent contractor is and what the independent contractor status means for workers and employers, read below:
Most people who perform work for someone else are considered employees of that person or company. However, an alternative arrangement is to consider those who perform work to be independent contractors. The difference between employees and independent contractors is more than just the title.
If you are an “independent contractor,” your working terms are decided by an agreement or contract. The terms of the agreement may be a formal written contract, or may just be a verbal agreement. In fact, a contract for work can be created simply by doing things the way they have always been done, without writing down the terms and without even talking about them. However, even if your employer labels you an “independent contractor,” the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) may still consider you to be an employee based on the nature of your work relationship.
An employee is on a company’s payroll and receives wages and benefits in exchange for following the organization’s guidelines and remaining loyal. An independent contractor is worker who has autonomy and flexibility but does not receive benefits such as health insurance and paid time off. See the IRS website for more information on employee classification and how it impacts taxes.
No. There is a federal rule that governs whether an individual is an employee or independent contractor. The Fair Labor Standards Act Independent Contractor Rule states that employers should generally follow these federal independent contractor standards to determine if a worker is an independent contractor or an employee:
- Economic reality test. This test focuses on whether the worker is in business for themselves or if they are economically dependent on an employer for work.
- Core factors. Core factors looks at the nature and degree of control of the work provided for an employer along with the worker’s opportunity for profit or loss based on initiative and/or investment.
- Additional guidance. Three other factors are considered under the act when the two core factors do not point to the same classification.
- The amount of skill required for the work.
- The degree of permanence of the working relationship between the worker and the potential employer.
- Whether the work is part of an integrated unit of production.
See the Department of Labor website for more information.
The IRS wants to be sure that proper federal taxes are being paid. The IRS collects income taxes from employers and employees. Taxes are deducted from employee paychecks. The employer is required to forward to the IRS the money collected from the employee deductions. If an employer is not properly taking deductions or forwarding the money, the IRS may act against the employer to correct the tax violations.
If an independent contractor is involved, the IRS has no authority to act against the employer, but the IRS does have the authority to audit the tax payments of the independent contractor. Contractors who earn over a certain amount also must pay what is known as a “self-employment tax,” which covers their share of Social Security taxes.
Under IRS rules, workers are presumed to be employees. The burden is on the employer to prove that a worker is an independent contractor and not an employee. The IRS has recently simplified their previous list of 20 factors into a 3 category evaluation system to determine whether a worker is an employee or an independent contractor.
These 3 categories: (A)Behavioral Control, (B) Financial Control, and (C) Type of Relationship, include a total of 13 factors. The importance of each factor depends on your particular situation. These categories are detailed below:
Type of Instructions Given: Employees must follow the instructions of the employer as to when, where, and how to perform the work. Independent contractors can set their own hours and decide how to perform the job or complete the project. The company will review the finished project.
Degree of Instruction: Degree of Instruction means that the more detailed the instructions, the more control the business exercises over the worker and the closer the worker is to an employee. Less detailed instructions reflect less control, indicating that the worker is more likely an independent contractor.
Evaluation: If an evaluation system measures the details of how the work is performed, then these factors would indicate that you are an employee. If the evaluation system measures just the end result, then you could be either an independent contractor or an employee.
Training: The employer may hold classes, meetings or closely supervise on-the-job to train employees. Independent contractors can perform the work as they choose.
Significant Investment: Employees do not invest in the facility and do not buy equipment. Independent contractors must invest in their own workplace and equipment.
Unreimbursed Expenses: Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with the services that they perform for their business.
Opportunity for Profit or Loss: The profit or loss of the company does not change the pay that employees earn. Independent contractors can profit or lose money based on good or bad results and time spent working on the project.
Services Available to the Market: Employees generally serve one employer. Independent contractors can provide services to the general public, advertise services, and recruit new customers–all while working for one or more other companies.
Method of Payment: Employees are paid on specific dates in regular amounts, and may be reimbursed for travel and business expenses. The contract between the company and the independent contractor determines how payment is to be made. Independent contractors may include expenses as part of the contract or may pay expenses independently.
Type of Relationship
Written Contract: Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker’s status. The IRS is not required to follow a contract stating that the worker is an independent contractor, responsible for paying his or her own self-employment tax. How the parties work together determines whether the worker is an employee or an independent contractor.
Employee Benefits: Employee benefits include things like insurance, pension plans, paid vacation, sick days, and disability insurance. Businesses generally do not grant these benefits to independent contractors. However, the lack of these types of benefits does not necessarily mean the worker is an independent contractor.
Permanency of the Relationship: Employees have an ongoing relationship with the employer. Independent contractors are hired for a specific job. When that job is finished, the working relationship ends.
Services Provided as Key Activity of the Business: If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship.
The Department of Labor (DOL) monitors and regulates the wage and hour laws passed by Congress. If for example, an employee is not paid minimum wages or overtime, the DOL may act to correct the unfair or unlawful wage practices. If an independent contractor is involved, the DOL has no authority to act.
The Department of Labor states that “economic realities” factors are helpful guides to determine whether a worker is an employee or an independent contractor. While there is no single rule or test, the Supreme Court has held that it is the totality of the working relationship between the worker and employer that is determinative.
Although the factors considered can vary, the factors generally considered to determine whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA) include:
The extent to which the work performed is an integral part of the employer’s business. If your duties are an integral part of the business, that fact leans toward finding you to be an employee. If your duties are not central to the primary business, that fact leans toward finding you to be a contractor.
Whether the worker’s managerial skills affect his or her opportunity for profit or loss. Managerial skill may be indicated by the hiring and supervision of workers or by investment in equipment. Analysis of this factor should focus on whether the worker exercises managerial skills and, if so, whether those skills affect that worker’s opportunity for both profit and loss. An employee usually has a set wage and only shares in the profits or losses of the business under a shareholder agreement or benefit program. A contractor can be more profitable by performing their services more efficiently. The profits and losses of a contractor are not linked to the profits and losses of the business that is using your services.
The relative investments in facilities and equipment by the worker and the employer. The worker must make some investment compared to the employer’s investment, and bear some risk for a loss, in order for there to be an indication that he/she is an independent contractor in business for himself or herself. A worker’s investment in tools and equipment to perform the work does not necessarily indicate independent contractor status, because such tools and equipment may simply be required to perform the work for the employer. If a worker’s business investment compares favorably enough to the employer’s that they appear to be sharing the risk of loss, this factor indicates that the worker may be an independent contractor.
The worker’s skill and initiative. As a contractor, you are free to exercise your own initiative and judgment. You can take advantage of open market competition to set your prices and pick your work. The employee is required to follow directions from the employer and under normal circumstances cannot compete with the employer.
The permanency of the worker’s relationship with the employer. More permanent relationships create an employee-employer relationship. Temporary services are more likely to create a contractual relationship.
The nature and degree of control by the employer. The more control the business has over the work you do, the more likely you are to be an employee. If you are free to perform your services without detailed direction or supervision, you are more likely to be a contractor.
The rise of on-demand services provided through app/web-based companies brings new challenges to worker classification. See our page on Gig Workers for more information on the law.
Not necessarily. The time or method of payment is just one of the factors considered when deciding if you are an employee or a contractor. While a flat fee payment arrangement makes it more likely that you are an independent contractor, it is the totality of the circumstances of the working relationship that will ultimately determine whether you are an employee or independent contractor. Otherwise, employers could just offer each employee a flat fee for the completion of work, or choose any particular method that might circumvent the laws.
An employer is not responsible for your unemployment benefits if you are an independent contractor. While employees are eligible for unemployment benefits if they are laid off, an independent contractor will only be eligible if they pay separately into the state unemployment fund.
However, if your status as an independent contractor is questionable, filing for unemployment may be worth a try. While cases considering Uber drivers’ employment status are still making their way through the courts, a Florida Uber driver recently filed for and was granted, unemployment benefits as an Uber employee.
As with unemployment benefits, an employer is not responsible for workers comp benefits if you are an independent contractor. Most states permit an independent contractor to be eligible for workers compensation benefits by paying separately into the state workers compensation fund.
Only employees are covered under federal discrimination laws. Some states have discrimination laws that define “employee” more broadly than the Internal Revenue Service and Department of Labor. You should check your state and local discrimination laws to see if you would be covered, or consult with a local attorney who can help you find out how you might be protected.
Under the Affordable Care Act employers with 50 or more full-time employees, or a combination of full and part time employees equivalent to 50 full time employees, who do not provide a minimum level of affordable healthcare coverage to their employees may be required to make an “Employer Shared Responsibility” payment if at least one of their full-time employees receives a premium tax credit for purchasing individual coverage on one of the new Affordable Insurance Exchanges, also called a Health Insurance Marketplace (Marketplace).
Furthermore, if an employer subscribes to an IRS-approved medical plan that covers all employees, that plan must provide coverage without discrimination. If you are an independent contractor, you must provide your own health coverage.
The Internal Revenue Service regulates the amount all people must pay for income taxes and contributions to Social Security, Medicaid, Medicare, etc. These taxes are automatically deducted from an employee’s paycheck. As an independent contractor, you must pay your own taxes. However, as an independent contractor, you may also take deductions for all of your business expenses, so you may actually end up paying lower taxes than an employee.
No, if you fit the definition of an employee, your employer is required to treat you as an employee and take payroll deductions. Both you and your employer could be charged a penalty if you try to avoid the wage and hour or tax laws that control the employee-employer relationship.
First, you should have a written agreement that explains why you are an independent contractor and not an employee. The company must be willing to give you broad discretion in how, when, and where you perform your duties. You must review all of the Internal Revenue Service and Department of Labor factors to be sure that your agreement considers all of those factors.
Talking to company management is a good start. If your management is alerted that there may be a problem with your classification, that may be enough incentive for them to change your status to comply with the Internal Revenue Service and Department of Labor factors.
If you are presently an employee and want to become an independent contractor, your job assignments must be consistent with the Internal Revenue Service and Department of Labor factors. You should discuss your request with management to see if the company is willing to give you the freedom to be an independent contractor.
If there are job openings, you can apply for an employee position. The solution may be difficult If the company insists on treating you as an independent contractor and you believe your situation fits the Internal Revenue Service and Department of Labor factors that define an employee.
You should talk to an attorney who can help you analyze your situation. Then, you can decide whether going to management or going to a government agency is the best way to address your concern.
First, you should talk to an attorney who can help you analyze the Internal Revenue Service (IRS) factors. Even though reporting IRS violations is a protected activity, you might expose yourself to unlawful retaliation. If you want the IRS to determine whether you are an employee, you can file an IRS Form SS-8.
The IRS also has a hotline (800-829-0433) where you can make a report. For more information, and/or other ways to report IRS violations, see the IRS page, How Do You Report Suspected Tax Fraud Activity?
The Internal Revenue Service, the Department of Labor (DOL), and similar state agencies enforce wage, hour, and tax laws. Independent contractors have to go to court to enforce their independent contractor agreement.
The Fair Labor Standards Act (FLSA) is enforced by the Wage-Hour Division of the DOL. The Wage-Hour Division’s enforcement of the FLSA is carried out by investigators stationed across the U.S. who conduct investigations and gather data on wages, hours, and other employment conditions or practices in order to determine whether an employer has complied with the law. Where violations are found, they also may recommend changes in employment practices to bring an employer into compliance.
It is a violation of the FLSA to fire, or in any other way discriminate against an employee, for filing a complaint or participating in a legal proceeding.
Willful violations of the FLSA may be prosecuted criminally and the violator fined up to $10,000. A second conviction may result in imprisonment. Employers who willfully or repeatedly violate the minimum wage requirements are subject to a civil money penalty of up to $1,000 for each such violation.
The FLSA makes it illegal to ship goods in interstate commerce that were produced in violation of the minimum wage, overtime pay, child labor, or special minimum wage provisions.
To contact the Wage-Hour Division for further information and/or to report a potential FLSA independent contractor violation, call:
Toll Free: 866-4-USWAGE (866-487-9243) TTY: (877) 889-5627 (available Monday – Friday, 8 a.m. – 6 p.m. Eastern Time)
You may also contact your local Wage-Hour Division office. If you need further information about your state’s law relating to independent contractors and/or wish to report a potential state law violation, then you may wish to contact the agency in your state which handles wage and hour/labor standards violations, listed on our site’s state government agencies page.
If an agency or a court finds that you should have been treated as an employee, the company could be forced to classify you as an employee. If you lost income or benefits because you were not classified as an employee, you could be compensated for those losses.
There are several different methods under the Fair Labor Standards Act (FLSA) for an employee to recover unpaid wages; each method has different remedies.
The Wage-Hour Division of DOL may supervise the payment of back wages.
The Secretary of Labor may bring suit for back wages and an additional penalty, called “liquidated damages,” which can be equal to the back pay award (essentially doubling the damages) if an employer willfully violated the statute.
An employee may file a private lawsuit for back pay and an equal amount as liquidated damages, plus attorney’s fees and court costs. An employee may not bring a lawsuit if he or she has been paid back wages under the supervision of the Wage-Hour Division or if the Secretary of Labor has already filed suit to recover the wages.
The Secretary of Labor may obtain an injunction to restrain any person from violating the FLSA, including the unlawful withholding of proper minimum wage and overtime pay.
Your state law may have different methods for recovery of unpaid wages, and different remedies to be awarded to those who succeed in proving a violation. For further information, please contact the agency in your state which handles wage and hour/labor standards violations, listed on our site’s state government agencies page.
To file a complaint for unpaid wages under the Fair Labor Standards Act, you may either go to the Wage-Hour Division of Department of Labor, which may pursue a complaint on your behalf or file your own lawsuit in court (which may require you to hire an attorney).
Do not delay in contacting the Wage-Hour Division or your state agency to file a claim. There are strict time limits in which charges of unpaid wages must be filed. To preserve your claim under federal law, you must file a lawsuit in court within two years of the violation for which you are claiming back wages, except in the case of an employer’s willful violation, in which case a 3-year statute applies. However, as you might have other legal claims with shorter deadlines, do not wait to file your claim. You may wish to consult an attorney before filing your claim, but you are not required to have an attorney to file a claim with the state and federal administrative agencies.
Your state wage law may have different deadlines for recovery of unpaid wages. For further information, please contact the agency in your state which handles wage and hour/labor standards violations, listed on our site’s state government agencies page.