(This column originally appeared in the Inquirer)
Do you classify workers as independent contractors or employees? The difference could be very expensive for business owners, and the rules are in flux.
Businesses can save on employer taxes, overtime pay, worker’s compensation, and employee benefits when using independent contractors. But the worker classification rules, which the Biden Administration changed in 2022, are complicated.
And now things are getting even more complicated.
That’s because the U.S. Department of Labor recently published a list of all rules it is re-scrutinizing, and worker classifications are a priority. According to HR Dive, a human resources trade publication, the Labor Department “has already posted a bulletin to field staff directing employees not to enforce the Biden-era independent contractor rule and instead to apply earlier enforcement guidelines in certain matters.”
“There’s been sort of a shift back and forth in the interpretation and guidance with regard to independent contractor rules,” said Josh Ganz, a labor and employment attorney at Duffy North in Hatboro. “However, I think there’s still very much a baseline that you have to follow.”
So while these regulations are being readdressed, what should your business do to make sure you’re properly classifying your employees?
Focus on the key tests
Some things aren’t likely to change, and there are many potential red flags to indicate that a worker is likely an employee rather than a contractor.
Examples include whether you’re paying that worker similar to other hourly employees, including that worker in your payroll system, requiring the worker to only use your tools and materials, and setting restrictions on the hours worked. Other key questions include whether an on-site presence is needed, and whether you’re requiring that worker to remain exclusive to your company.
But Jeff Burke, an employment law partner at MacElree Harvey in West Chester, said the key distinction is control and independence.
“If the business controls the worker’s schedule, tools, and how the work is done then it’s more of an employer-employee relationship,” he said. “It really comes down to a two-prong test: whether the folks are free from control and whether they’re customarily engaged in an independently established trade.”
Make sure your independent contractors are truly independent
According to Burke, employers should be able to show that contractors operate independently in the market. Auditors often look to see that a contractor has business cards, a website, or a separate business formation — such as a limited liability company or corporation — as proof. Lack of this evidence is a common cause of failure in audits.
“I’ve seen people get burned on audits for any of these reasons,” he said. “You need to make sure you have records that show that they’re actually engaged in the independent trade. If they set up an LLC and you’re doing a business-to-business contract, you are way more likely to pass muster.”
Ganz agrees and often tells his clients to ask themselves whether they’re controlling that worker’s entire day, telling that worker where to be, and requiring them to use company tools.
That’s “the baseline test,” he said. “If I hire someone to design a logo for $2,500 due in two weeks, that’s the epitome of an independent contractor. But if they work in my office 9 to 5 doing ongoing projects, that’s an employee.”
Have an independent contractor agreement
Having an agreement with a contractor will help define and document your relationship. And for that reason, many attorneys recommend having a contract.
“It must be in writing and explicitly state the relationship,” said Burke. “It should clarify that the contractor is doing things like assuming responsibility for their own taxes and insurance and bears financial responsibility for their work. It should also be project-based, not indefinitely engaged.”
Such agreements are important for clarifying expectations, Ganz said, such as payment terms, scope of work, and liabilities. But no matter how good the contract is, it still doesn’t override the law, he noted.
“Classification depends on legal definitions, not contract language,” he said. “Just because you enter into an independent contractor agreement it does not thereby create an independent contractor situation. It’s a definition of law, not by the agreement.”
Don’t forget state, local, and tax rules
Although the federal government may change its worker classification rules there’s no guarantee that Pennsylvania, New Jersey, or the Internal Revenue Service — which all have separate rules — will follow along.
Both Burke and Ganz advise following the “strictest application test” since a liability can arise under any jurisdiction.
“You kind of have to balance everybody’s rules at the same time,” said Ganz. “And everybody thinks they’re just as important as the next.”
Understand your risks
Not complying with the independent contractor rules can result in substantial penalties as well as potential obligations to pay back taxes, overtime pay, or employee benefits such as retirement and healthcare contributions. An employer could also be subject to civil lawsuits for wage-and-hour claims.
Pleading confusion isn’t going to protect you.
“I admit that right now it’s kind of a bit of the Wild West,” said Ganz. “But at the end of the day, there’s a pretty clear-cut line about what’s an independent contractor and what’s an employee.”
