Earlier this summer, the Department of Labor (DOL) issued an Administrator’s Interpretation letter (to view it, click here: http://online.wsj.com/public/resources/documents/InterpretMisclass.pdf), penned by administrator David Weil, to help employers distinguish between employees and contractors and classify them accordingly.
In the letter, Weil said employers and courts should use the DOL’s six-factor “economic realities” test to determine whether someone is a true independent contractor or not by measuring a person’s “economic dependence” on a single business, with the greater a person’s dependence on that business, the more likely it is that that person is an employee.
The six factors, listed below, are set up so that no one factor is more important than the other and instead must all to be examined as a whole:
1. The extent to which the work performed is an integral part of the employer’s business
2. The worker’s opportunity for profit or loss depending on his or her managerial skill
3. The extent of the relative investments of the employer and the worker
4. Whether the work performed requires special skills and initiative
5. The permanency of the relationship, and
6. The degree of control exercised or retained by the employer
However, one month after the DOL issued the letter, the IRS posted a fact sheet on its website (to view it, please visit: http://www.irs.gov/uac/Newsroom/Payments-to-Independent-Contractors) that makes no mention of the DOL’s “economic realities test,” and instead points out a series of “Common Law Rules” for determining whether someone’s an independent contractor. These rules include:
1. Behavioral: Does the business owner control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the business owner? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits such as pension plan, insurance or vacation pay? Will the relationship continue and is the work performed a key aspect of the business?
The IRS claims that if you can answer yes to even one of these questions, you’ve likely got an employee versus a contractor.
So what does that mean for you as the actual employer? Despite the DOL’s best efforts to create a single way to determine independent contractor classifications, the IRS’s guidance appears to have unintentionally undermined the agency’s efforts.
With that in mind, employers should still run their employees through both sets of tests and see on which side they fall. If they pass, great. If not, change your working relationship so they do or simply reclassify the worker in question and compensate them as an employee with the associated tax deductions, benefits and other perks and pitfalls of being an in-house worker.