Employee Misclassification: What Constitutes an Employee and an Independent Contractor?

When an organization is looking to retain the services of a worker, they can choose to hire employees or independent contractors.  And depending on the hiring classification, there are respective obligations and responsibilities.

But just because an employer refers to their worker as an employee or independent contractor does not make it so. In the event the classification is challenged by a government agency or in court, there are several different standards a reviewing body could consider when deciding which classification is right.

Employee vs Independent Contractor

What is the difference between an independent contractor versus an employee? Simply put, independent contractors are typically workers who own their own businesses and enter into project-specific contracts with employers.  In contrast, employees are those who work for a single employer on a regular basis.

Sometimes it can be easy to differentiate between the two classifications. Other times, it can be hard.  To help avoid the consequences of misclassification, there are a number of tests to evaluate a worker’s status.

1. IRS common law test

The Common-Law Test is a set of factors traditionally relied on and developed by courts within the United States.  The IRS has adopted these factors when it must review a classification.  So, for example, let’s say an employer has hired a 1099 employee.  Side Note. What is a 1099 employee? Well, a 1099 employee is actually a misnomer as it actually refers to independent contractors not employees. So really, they should be called 1099 contractors. At the end of the year, the employer will send its contractors a form 1099 instead of a form W-2. But what if the IRS questions the status of the 1099 contractors and thinks they should be treated as full-time employees.

In making its determination, the IRS will use the common-law test to consider factors like how much control is exerted by an employer over a worker.  The greater the control, the more likely the worker will be considered an employee.

To avoid getting on the wrong side of the IRS, businesses must weigh all these factors when determining whether a worker is an employee or independent contractor.

2. The ABC Test

Unlike the IRS, which relies on common-law, judicially created factors, several states have adopted what is called the ABC test for determining whether an individual is an employee or an independent contractor.

The test derives its name from its three elements:

1. The work is done without the direction and control of the employer.
2. The work is performed outside the usual course of the employer’s business.
3. The work is done by someone who has their own, independent business or trade doing that kind of work.

If the work performed is typically done without employer direction and outside the usual course of business, by someone who has their own trade, he or she is more likely to be considered an independent contractor.

3. The NLRB’s new independent contractor standard

In a June 2013 ruling, the National Labor Relations Board (NLRB) altered the standard that employers must use when determining whether someone qualifies as an independent contractor.

Under previous standards, the NLRB would primarily consider entrepreneurial opportunity when looking to determine whether someone was an employee or independent contractor.  But under the new framework, entrepreneurial opportunity was relegated to consideration alongside the other, traditional common law factors.

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