By Jared Nusbaum
Small businesses routinely tell us that they don’t hire employees. Instead, they claim to hire independent contractors or subcontractors. They’re surprised to learn that the designation they provide has no weight when the government investigates proper or improper classifications.
An individual’s classification as an independent contractor, subcontractor or employee affects wage and benefit structures. In the United States, non-employees (independent contractors and subcontractors) pay self-employment taxes, while the employer pays half of an employee’s FICA (Federal Insurance Contributions Act) taxes. Further, an employer is required to withhold the employee’s portion of FICA taxes, and federal and state withholding taxes for payment to the appropriate taxing authority. Non-employees don’t earn overtime and aren’t eligible for job-protected leave under the federal Family and Medical Leave Act (FMLA).
Understanding the differences between employee and subcontractor matters. An employer who misclassifies employees as independent contractors or subcontractors can be liable for unpaid overtime wages and hefty fines from the U.S. Department of Labor (DOL).
It’s not enough to issue 1099s and have workers sign independent contractor/subcontractor agreements. Under the federal Fair Labor Standards Act (FLSA), worker status depends on the totality of circumstances under which work is performed, not the designation the employer assigns.
Who is an employee?
There’s no single test for who is an employee under the FLSA. Instead, courts and federal agencies look at six factors, summarized as follows:
1. Employer control. Does the employer set the worker’s hours, provide the worker’s tools or determine the methods the worker uses? If yes, this is like an employee.
2. Integral work. Does the worker provide the service that the employer is in business to provide? Is the worker engaged in production? If yes, this is more like an employee.
3. Relative investments of the employer and the worker. Has the worker made substantial investments for the purpose of sustaining a business beyond one specific project? If yes, this is more like a non-employee.
4. The worker’s skill and initiative. Does the worker have specialized skills enabling them to exercise independent business judgment? If yes, this is more like a non-employee.
5. Permanence of the work relationship. If the relationship is impermanent, did the worker choose that format (more like a non-employee), or is it the employer’s decision or a feature of the industry (more like an employee)?
6. Effect of managerial skill. Does the worker’s managerial skill affect the employee’s opportunity for profit or loss? Does the worker make independent decisions such as whether to hire more help? (Deciding whether to work more hours/more jobs doesn’t count here.) If yes, this is more like a non-employee.
These factors don’t all have to be present or absent. If only a few factors suggest non-employee status, the worker is probably an employee. Having the individual sign an independent contractor agreement, while useful, will not guarantee the individual is actually an independent contractor. The factors mentioned will be taken into account in determining the individual’s status.
Temporary and seasonal workers
Most temporary and seasonal workers are employees. For instance, their work is often integral to the employer’s work, the employer usually exercises significant control over their work and the impermanence of the work relationship is determined by the employer’s fluctuating need rather than the worker’s preference.
Do part-time, seasonal or temporary workers earn overtime? Yes, as long as they are employees and don’t qualify for an overtime exemption. Virtually all employees are covered by the FLSA, which requires that employees be paid at an overtime hourly rate for every hour over 40 worked in a given week. An overtime rate is at least 1.5 times the employee’s normal hourly wage. It doesn’t matter if the employee normally works less than 40 hours per week. Hours can’t be averaged across multiple weeks.
Overtime exemptions exist for certain managerial, administrative, skilled or highly compensated employees. Although those exemptions are beyond the scope of this article, they generally don’t apply to employees who perform manual labor.
Are seasonal employees eligible for unemployment benefits? It depends. In Minnesota, for example, employees may qualify if they have sufficient earnings within a “base period.” The base period is a yearlong phase ending within a certain time of the employee’s unemployment benefits application. The employee has to have earned at least 5.3% of the state’s average annual wage during the base period. Consult the laws governing your location to be certain you are in compliance.
Fixing a misclassification
If you hired workers as independent contractors/subcontractors but think they might actually be employees, it’s best to rectify the misclassification, understanding that it might cost you.
Depending on the hours the employees worked, you may owe back overtime wages, benefits or benefits payments. It’s probably safest to pay these amounts immediately if you can determine them because an audit by the DOL or an employee misclassification lawsuit could cost you substantial fines and or serious legal consequences.
Most courts reviewing the question of how to respond when misclassified employees have already paid self-employment taxes to the IRS have held that once paid, the employee can recover from the IRS but not from the employer. However, some courts have held that employers can be held liable. If you are concerned about your legal liability in this area, consult with an employment attorney.
Jared Nusbaum is an attorney with Zlimen & McGuiness, PLLC. His practice focuses on employment law, litigation, bankruptcy, and appeals. Contact him at email@example.com.