Contractor or Employee? How to Keep Classification Straight

There’s a new startup bandwagon on the loose, making regular stops around the tech world each week. It pulls up in the form of an article on the sharing economy and how one more rising startup is transitioning contract workers to employee status. One week it’s Luxe Valet, the next it’s Sprig, and don’t forget Shyp. Despite the trend itself—and the allure of some great press—the move really is one worth celebrating, for each of these companies. It’s not just a step towards longevity, but ultimately a business decision that puts their people, their employees, first. More benefits, more worker protections, and overall a more solid footing with the company are now theirs to enjoy.

 

The whole thing is a sexy way of bringing the very real issue of worker misclassification to the forefront of the news. Today, 40.4% of of the U.S. workforce is made up of contingent workers—that includes contract company workers, independent contractors, and agency temps. That stat is up from a 2005 measurement of 30.6%. Call it one of the many symptoms of advancing technology in our world of work today, as companies scramble to fill on-demand business plans and workers are more willing to be flexible. Whatever the cause, classifications are getting complicated.

 

Legislation Update

The Department of Labor (DOL) is taking notice of the new climate. The department recently put out an “Administrator’s Interpretation” meant to help employers determine whether workers are employees or independent contractors. The DOL sees a lot of worker misclassification out there, particularly when employers label workers as “independent contractors” rather than full-time employees, or even classify an employee wrongfully as “owner” or “partner” of a business to avoid the classification game altogether.

 

Shortly after the DOL’s warning that “most workers are employees under the FLSA,” TLNT reported that two senators, Bob Casey, D-PA, and Al Franken, D-MN, had proposed a bill, the Payroll Fraud Prevention Act of 2015, to crack down on worker misclassification by means of amendments to the Fair Labor Standards Act. One of the main tenets of the senators’ bill would be to provide written notice to workers regarding their classification as employee or non-employee.

 

The bill is unlikely to pass given the divided congress this term. But, as Ilyse Wolens Schuman points out on TLNT, because portions of the bill have appeared elsewhere, including in other legislation related to paycheck reporting requirements for federal contractor employees, the bill is definitely evidence of lawmakers and enforcement agencies alike taking note of the employee classification problem. Penalties in the proposed bill range from $1,100 in civil penalties to $5,000 if the violation is determined to be repeated or willful.

 

What to Do

Even if your company isn’t participating in the Uber-fication of a certain service (don’t even think about assembling a league of on-demand pancake chefs—my funding’s about to clear), the heightened scrutiny around worker classification is worth wrapping your head around.

 

As always, if you are unsure about the categorization of your employees, consult with your legal counsel and review the DOL guidelines as well as the “Administrator’s Interpretation” for your exact situation. Every company is different. That said, here are some steps to making sure your classifications are spic and span as your company scales up. When your startup hits the big time and makes the contractor employee switcheroo, you’ll be more than ready.

 

1. Start early.

Dan McCoy, the co-chair of the employment practices group at Fenwick & West in California, recently gave a fantastic interview in Forbes with Adriana Gardella regarding worker misclassification. Among his biggest pieces of advice was to start clarifying your classifications early on.

 

“Even if you decide to stay with contractor status for workers, at least address the issue with your board and investors,” he said.

 

Not only that, if you do decide to reclassify a population of your workers, do it when the company is smaller. McCoy suggests to tackle that when you’re closer to the 20-employee mark, not 120. “While you can still reclassify at that later stage, it becomes far more burdensome,” he said.

 

2. Familiarize yourself with what employees receive and contract workers do not.

Employees are entitled to certain protections that contract workers do not receive. This includes but is not limited to:

 

  • Minimum Wage
  • Overtime
  • Family and Medical Leave
  • Unemployment Insurance
  • Workers’ Compensation
  • Health Benefits. Under the Affordable Care Act (ACA), however, employees that work for an Applicable Large Employer (ALE) for more than 30 hours a week are entitled to healthcare benefits.

 

Knowing the specific protections guaranteed for employees at your own company is what classification is all about.

 

3. Understand how the DOL delineates between contractors and employees: Are your workers economically dependent on the employer (and thus an employee) or are they in business for themselves (and thus an independent contractor)?

The DOL’s “Administrator's Interpretation” lays out what employers need to consider when classifying workers. It essentially boils down to the question of economic dependence, what the DOL calls the “economic realities” test. Classifications can be complex, but it doesn’t hurt to familiarize yourself with the six areas of the “economic realities” test. Here they are, plus summaries of the real-world examples provided by the DOL for understanding each concept.

 

A. Is the employee’s work an integral part of the employer’s business?

Example: If a construction company frames residential homes, carpenters are integral to that business and thus likely to be employees.

 

However, if a software developer contracts with the same construction company and makes them software to help track bids, schedule projects, and track material orders, the developer is performing work that is not integral to the core business. That indicates an independent contractor relationship.

 

B. Does the worker’s managerial skill affect the worker’s opportunity for profit or loss?

Example: A yardwork company keeps corporate clients, and one of the yardwork company workers takes assignments from the company. Sometimes they schedule him for more work during the week, which he takes to earn some extra money. Other weeks they assign him less. He doesn’t advertise his yardworking services or solicit work from other clients. The worker’s lack of managerial authority indicates he’s likely an employee.

 

In contrast, a different worker may provide yardworking services himself for corporate clients—negotiating every contract, hiring helpers, recruiting new clients, and deciding which work to take and which work not to take. This worker would be an independent contractor because his managerial skill affects his opportunity for profit and loss.

 

C. How does the worker’s relative investment compare to the employer’s investment?

Example: A cleaning company may employ a worker who likes to bring a few of her own cleaning supplies to certain jobs, but the company also provides her a vehicle, insurance, and most equipment and supplies. She would be an employee.

 

An independent contractor, however, may provide cleaning services and sometimes work for a cleaning company, but she rents space to store her materials and a vehicle that she can only use for work. Couple that with her regularly marketing herself and she’s likely an independent contractor.

 

D. Does the work performed require special skill and initiative?

Example: A highly skilled carpenter may work for a firm, but might not execute any managerial or business skills. Instead, she does assigned tasks. That worker is likely an employee.

 

But, a highly skilled carpenter who makes made-to-order cabinets for many construction companies—and also markets herself and decides what jobs to take—could be a contractor.

 

E. Is the relationship between the worker and the employer permanent or indefinite?

Example: An editor would be considered an employee at a publishing house if she has a permanent working relationship there after working with them for several years. She uses their specifications and edits books they provide.

 

Another editor may work on a gig basis with fifteen other publishing houses over several years, negotiating jobs and turning down others. She is likely an independent contractor.

 

F. What is the nature and degree of the employer’s control?

Example: A nurse registry may oversee close control over a registered nurse who works for their clients, setting his wage range and requiring him to inform the registry when and where he works. The nurse is an employee.

 

A separate nurse registry may instead send client listings to a registered nurse, but let the nurse set his own wage range and work whenever he pleases. That nurse would not be considered an employee.

 

4. Use an online platform to handle payroll tax withholdings.

One of the reasons startups reach for the contractor status instead of employee classification is to avoid payroll complications like tax withholdings or workers’ compensation. But, that’s one liability that can catch up with a company. As McCoy told Forbes, a taxing authority might approach a company saying they owe a misclassified contractor payroll taxes. “The company can owe the tax, penalties for failing to pay the tax promptly, and interest,” he said.

 

But, companies don’t need to be afraid of payroll complications around employees. A full-service payroll system can take care of that, especially your automated tax filings. As goes with classifications, a bandaid solution now can mean major repercussions down the line. Instead, set yourself up for success with the proper classifications and a payroll platform that can handle what you need.

 

Once you have contractor and employee classifications sorted out, further classify exempt and nonexempt employees correctly!

 

Download Namely’s eBook,

Walking the Exempt and Nonexempt Employee Line