4 Tests to Determine Whether Your Workers Are Independent Contractors or Employees
One of the common challenges small businesses face is navigating the complex terrain of worker classification. The determination carries significant legal implications for your business.
To shed light on this complex issue, this guide will explore the different legal tests used to evaluate worker classification. By understanding these tests, we can navigate the intricacies of the employment relationship more effectively.
The control test:
One of the most commonly used legal tests is the control test, which focuses on the level of control exerted by the employer over the worker. It considers factors such as supervision, training, and the employer’s ability to dictate the details of the job. When an employer has the right to control how, when, and where the work is performed, the worker is more likely to be considered an employee. Conversely, if the worker has significant independence and control over their work, they are more likely to be classified as an independent contractor.
The Economic Reality Test:
The economic reality test takes a broader perspective and evaluates the economic relationship between the worker and the employer. It analyzes factors such as the degree of financial dependence, the opportunity for profit or loss, and the investment in equipment and materials. If the worker is economically dependent on the employer and relies on them for income, benefits, and resources, they are more likely to be classified as an employee. Conversely, if the worker operates as a separate business entity, takes financial risks, and has the potential for profit or loss, they are more likely to be considered an independent contractor.
The ABC Test:
Several states, such as California and Massachusetts, employ the ABC test to determine worker classification for labor law purposes. This test operates under the presumption that a worker is an employee unless the employer can demonstrate three elements: (A) the worker is free from the employer’s control, both in reality and according to the contract; (B) the work performed is outside the usual course of the employer’s business; and (C) the worker is customarily engaged in an independently established trade, occupation, or business. The ABC test places the burden on employers to prove independent contractor status.
The IRS Behavioral Control Test:
The Internal Revenue Service (IRS) has its own set of criteria for determining worker classification. The IRS behavioral control test examines three categories: behavioral control, financial control, and the type of relationship. Behavioral control focuses on whether the employer has the right to control how the worker performs their tasks, including the methods and tools used. Financial control factors include the extent of unreimbursed business expenses and the opportunity for profit or loss. The type of relationship considers written contracts, employee benefits, and the permanency of the working relationship.
As small business owners, understanding the legal tests for worker classification is crucial to ensure compliance with employment laws and mitigate potential legal risks. The control test, economic reality test, IRS behavioral control test, and the ABC test provide frameworks for assessing the employment relationship.
As we navigate the complexities of worker classification, let’s strive for fairness and transparency in our working relationships. By familiarizing ourselves with the legal tests and seeking the right expertise when needed, we can confidently make informed decisions that benefit both our businesses and the workers involved.
Adam Yohanan represents entrepreneurs, investors, freelancers, startups, small businesses, artists, and entertainers in a wide variety of transactional and regulatory matters, with an emphasis on complex commercial contracts, business formations, corporate governance, M&A, finance, intellectual property, and entertainment law. His office can be reached at 212-859-5041.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.