By Leslie Lasher

leslielasherOne of the first considerations when hiring new employees is ensuring that they are properly classified as employees or contractors. While many businesses perceive classification as an area of simplicity, it is, in fact, fraught with complexity due to the multiple layers of risk associated with attempting to comply with several state and federal laws.

Another common misconception is that the classification does not matter until you have a certain number of employees.  In reality, it applies to every person you contract with for work, even the first person.  Large businesses and small businesses both struggle with this issue, and so do our Courts: just Google Uber, Amazon, and FedEx, or read the News & Observer’s recent series on this issue and you will see that misclassification is at the forefront of the state and federal political and legal landscape. The US Department of Labor and the North Carolina Industrial Commission (which implements the North Carolina Workers’ Compensation Act), even entered a special Memorandum this year focusing on worker misclassification.

So, where do you start? First, an employer should consider the differences in how it treats contractors and employees. With regard to wages and compensation, an employer is not required to meet standards regarding the minimum wage, nor are they required to pay for overtime or vacation to contractors.  From federal and state taxing perspectives, businesses are not required to keep wage and hour records, nor are they required to withhold income taxes or FICA. While businesses are not required to carry workers’ compensation insurance on their contractors and are thus not (typically) liable under workers’ compensation laws for workplace industries.   Contractors also do not count toward calculating unemployment insurance, and I-9 verification is not typically needed.

Why Classification Is So Important

Seeing the benefits of classification as a contractor, many employers simply assign a title of “1099,” “Contractor,” or “Consultant” with little thought as to what happens if the classification is incorrect.  The risks are multi-fold, but a few to highlight include:

  • Under the Fair Labor Standards Act (FLSA), the employer could be liable for two to three years of back owed overtime compensation, plus liquidated damages, costs and fees.
  • With the Internal Revenue Service (IRS) the employer could face multiple consequences, including a penalty of 1.5 percent of wages owed/paid, up to 40% of the missing FICA contributions, and interest on under-withheld amounts, just to name a few.
  • For workers’ compensation, daily penalties of $50-100 will incur for imposing coverage, and employers and the employees who are in charge of making the classification decision, may be subject to criminal charges.

Definitions and Tests

The different regulatory bodies at the state and federal level, as well as applicable statutes, often fail to give clear definitions of an “employee.” The IRS has no real definition, while FLSA ops for the quite limited and a little too obvious “any individual employed by an employer.” These and other definitions of an “employee” are of little help to employers looking to discern the real differences between employers and contractors.

Instead, many agencies have created tests, which suggest balancing the attributes of the relationship between the employer and the worker in order to determine whether the worker is an employee. Under FLSA, we have the Economic Realities Test, and with the IRS, we have the “Twenty Factor Test” that focuses on the right to control the person’s work.  North Carolina law primarily focuses the application of common law principles. As is the case with any legal “test” – it changes slightly almost every time a new lawsuit is initiated, and fluctuates based on the facts of each particular industry and relationship.

Regardless, here are the basics to assist in the classification of your workers.   I typically suggest considering all of the tests when deciding whether a person should be an employee or a contractor. Based on the most recent trends, I suggest hyper-focusing on the employer’s right to control the person’s work, and the economic dependence of the worker on the employer.

Basic Common Law Factors (North Carolina Wage and Hour Act, Workers’ Compensation)

The worker:

  • Is engaged in an independent business, calling, or occupation.
  • Has independent use of special skill, knowledge, or training.
  • Is doing a specified piece of work at a fixed price, for a lump sum, or on a quantitative basis.
  • Is not subject to discharge for his method of work.
  • Is not in the regular employ of the contracting party.
  • Is free to hire assistants.
  • Has full control over his assistants.
  • Selects his own time.

Economic Realities Test (FLSA)

Consider the following items, among other things:

  • The extent to which the work performed is an integral part of the employer’s business.
  • Whether the worker’s skills affect his or her opportunity for profit or loss.
  • The relative investments in facilities and equipment by the worker and the employer.
  • The worker’s skill and initiative.
  • The permanency of the relationship.
  • The nature and degree of control by the employer over the worker.
  • Nature of the work, and location of work provided by the worker.

The bottom line is that if you need workers, you should closely consider whether the worker is an employee or a contractor. Remember, even if you get it right at the outset, relationships evolve over time, and at some point, many perfectly valid independent contractor relationships cross over and become employees. It is always a good idea to take a look at your relationships every year or so, just to confirm the status, and in an effort to avoid the steep penalties that may result from non-compliance.

If you have questions regarding employment matters, such as proper classification of your workers, email me at the firm today to get the answers you need.