Misclassifying employees can be a costly mistake for small business owners
Here's what small business owners need to know about the differences between an independent contractor and an employee, the tests used to properly classify employees, the risks of misclassification, and best practices to consider to avoid liability.
The decision to classify workers as independent contractors versus employees is one that many small businesses often use to save the company money. However, making this decision purely based on financial considerations can potentially lead to severe consequences and expose companies to legal liability.
Given this framework, it is important to have a firm understanding of the differences between an independent contractor and an employee, the tests currently used to properly classify employees, the risks of misclassification, and best practices to consider to avoid liability.
The Basics
Generally, an independent contractor is a person who works for themselves and performs contracted services for another person or entity. In most cases, a written agreement spells out the terms of service, and the business pays the independent contractor upon completion of the job or project, leaving the manner of performing the work to the discretion of the independent contractor.
In other words, the agreement governs what the work is, not how it will be executed.
Employees, on the other hand, have less autonomy, as the employer directs their work. The employer has the right to dictate when and where employees perform work, how they perform work, what tools or methods employees must use, and to monitor the work, including through disciplining employee performance. In exchange, employees receive hourly wages or a salary, and often receive employer-sponsored benefits, such as insurance and paid leave.
Companies must withhold appropriate taxes for employees and report earnings on a W-2 form, whereas independent contractors are not subject to the same employment taxes. Typically, contractor income is reported on IRS 1099 forms.
Another critical difference is that employees receive certain protections and benefits under federal and state employment laws, such as minimum wage and overtime benefits under the Fair Labor Standards Act (FLSA) and protections from discrimination under Title VII. Independent contractors generally do not receive the same benefits.
In short, wrongly classifying an individual as a contractor instead of an employee can deprive the worker of benefits provided by law. In turn, correctly classifying workers becomes paramount.
The Tests
Currently, there is no uniform definition or test that states or courts use to define an independent contractor. But the right to control is always in the forefront: who, the employer or the individual, has control over the work.
Consistently, Florida, along with the Internal Revenue Service (IRS), uses the Common Law Test to determine who is an employee. This test generally presumes a worker is an independent contractor, unless there is behavioral control (direction or control over where, when, and how the worker performs delegated tasks), financial control (right to control workers’ finances, including opportunities to reimburse for expenses or opportunities to earn other income), or other evidence based on the relationship of the parties (such as contracts describing the relationship, whether benefits are provided, the duration of the relationship, etc).
Florida’s workers’ compensation statute is slightly different and requires an individual meet at least four of 12 factors to be classified as an employee.
Courts will generally first look to the agreement between the parties to determine the status of the worker, so having an updated and accurate independent contractor agreement in place is essential. If the agreement explicitly states that the worker is an independent contractor, courts will usually honor that provision, unless the parties’ actual practice contradicts the agreement.
The Future?
The Biden administration is currently engaged in rule making under the FLSA, with indications it could move toward the “ABC” test put forth by over 30 states and the Department of Labor.
Under this test, the three factors to consider are:
- Absence of Control: whether the worker is free from the control and direction of the hiring entity in connection with the performance of the work (both under the contract for the performance of the work and in fact);
- Business of Worker: whether the worker performs work that is outside the usual course of the hiring entity’s business; and
- Customarily Engaged: whether the worker is customarily engaged in an independently established trade, occupation, or business.
Misclassification Issues
Regardless of the applicable standard, misclassifying employees can be a costly mistake, especially as government agencies begin to increase enforcement efforts. Businesses face consequences such as wage claims, fines and penalties, back taxes, class action lawsuits, increased benefit coverage, and reputational harm. Courts have not been afraid to grant multi-million dollar awards in misclassification cases.
Best Practices
Because each situation depends on its own facts, companies may consider classification of employees on a case-by-case basis. Below are several best practices small business owners may consider to minimize liability:
- Consider the reasons for the engagement – ask are the individuals truly independent or do they rely on the employer and perform the same work as employees – in making the decision to engage a contractor or hire an employee.
- Review independent contractor agreements with an attorney, and ensure each contains clear scopes of work.
- Avoid treating independent contractors like employees. For example, limit providing contractors with uniforms, company email addresses, or access to non-essential trainings.
- If operating in multiple jurisdictions, abide by the appropriate test in each state.
- Seek an expert’s opinion in tricky situations, or err on the side of classifying the worker as an employee.
About the authors:
Sarah Kuehnel is a shareholder in the Tampa and St. Louis offices of Ogletree Deakins. She has devoted her entire career to providing litigation and counseling services to employers.
Elizabeth Jozsi is an associate in the Tampa office of Ogletree Deakins where she is a member of the labor and employment practice group.