VI.  DISTINCTION BETWEEN EMPLOYEES AND INDEPENDENT CONTRACTORS AND RELATED ISSUES

A. Wage and Hour Laws

The term "independent contractor" is not defined in the FLSA. As previously noted, however, the federal courts have applied an "economic realities" test to determine whether an individual is an independent contractor. The fundamental question is: Does the employer have the right to control the worker's terms and conditions of employment? The most important factors in answering this question are:

1. the degree of the alleged employer's right to control the manner in which the work is to be
   performed;

2. the alleged employee's opportunity for profit or loss depending upon his or her managerial skill;

3. the alleged employee's investment in equipment or materials required for his or her task, or his or her employment of assistants;

4. whether the service rendered requires a special skill;

5. whether the service rendered bears an integral relationship to the alleged employer's business;
   and

6. the degree of permanence of the working relationship.1

 The courts generally examine all of these factors to determine whether, as a matter of economic reality, the workers were dependent upon the organization to which they rendered service, thereby creating an employment relationship.

 B. Employee Benefits

Generally, issues arising under most broad-based employee benefit plans (e.g., pension, 403(b), health care, disability, life insurance, etc.) are governed by the Employee Retirement Income Security Act of 1974 ("ERISA") (or, in the case of tax qualification issues, the Internal Revenue Code (the "Tax Code")) rather than by state law. Under ERISA, the Supreme Court has held that the following thirteen factors should be considered in determining whether an employer-employee relationship exists:

1. the hiring party's right to control the manner and means by which the project is accomplished;

2. the skill required;

3. the source of the instrumentalities and tools;

4. the location of the work;

5. the duration of the relationship between the parties;

6. whether the hiring party has the right to assign additional projects to the hired party;

7. the extent of the hired party's discretion over when and how long to work;

8. the method of payment;

9. the hired party's role in hiring and paying assistants;

10. whether the work is part of the regular business of the hiring party;

11. whether the hiring party is in business;

12. the provision of employee benefits; and

13. the tax treatment of the hired party.^1a

C. Employment Tax Issues

Employers must be careful when classifying a worker as an independent contractors to avoid later imposition of a tax liability for misclassification of that worker. While a determination that a worker is not an employee relieves the employer from the tax liabilities and reporting responsibilities that otherwise are required, the misclassification of a worker as an independent contractor can result in harsh employment tax penalties.

 The IRS has developed twenty factors that it uses on a case-by-case basis to determine whether a worker is an independent contractor or an employee. Although some of the factors are unique to federal tax analysis, many are the same as those used by the courts to resolve the issue in a variety of contexts. Note that no one factor is determinative; all factors need to be considered. When in doubt, the safest course is to treat the worker as an employee. 

An organization that contracts with government agencies for funding cannot rely on the classifications given to individuals by the government contracting agencies. A worker deemed a "consultant" or "contractor" under a government contract might be deemed an employee for IRS purposes. 

The factors considered by the IRS are: 

1. Instructions. A worker who is required to comply with the employer's instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the employer has the right to require compliance with instructions.

2. Training. Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the employer wants the services performed in a particular method or manner thus indicating an employer-employee relationship.

3. Integration. Integration of the worker's services into the organization's operations generally shows that the worker is subject to direction and control. When the success or continuation of an organization depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the employer. 

4. Services rendered personally. If the services must be rendered personally, presumably the employer is interested in the methods used to accomplish the work as well as in the results. 

5. Hiring, supervising, and paying assistants. If the employer hires, supervises, and pays assistants, this factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates independent contractor status. 

6. Continuing relationship. A continuing relationship between the worker and the employer indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals. 

7. Set hours of work. The establishment of set hours of work by the employer is a factor indicating control. 

8. Full time required. If the worker must devote substantially full time to the business of the employer, that employer has control over the amount of time the worker spends working and impliedly restricts the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses. 

9. Doing work on employer's premises. If the work is performed on the premises of the employer, that factor suggests control over the worker, especially if the work could be done elsewhere. Work done off the premises of the employer, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the employer has the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required. 

10. Order or sequence set. If a worker must perform services in the order or sequence set by the employer, that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the employer. Often, because of the nature of an occupation, the employer does not set the order of the services or sets the order infrequently. It is sufficient to show control, however, if the employer retains the right to do so.  

11. Oral or written reports. A requirement that the worker submit regular or written reports to the employer indicates a degree of control. 

12. Payment by hour, week, month. Payment by the hour, week or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying the lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor. 

13. Payment of business and/or traveling expenses. If the employer ordinarily pays the worker's business and/or traveling expenses, the worker is ordinarily an employee. To be able to control expenses, an employer generally retains the right to regulate and direct the worker's business activities.  

14. Furnishing of tools and materials. The fact that the employer furnishes significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship. 

15. Significant investment. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the employer for such facilities and, accordingly, the existence of an employer-employee relationship. Special scrutiny is required with respect to certain types of facilities, such as home offices. 

16. Realization of profit or loss. A worker who can realize a profit or suffer a loss as a result of the worker's services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee. For example, if the worker is subject to a real risk of economic loss because of significant investments or a bona fide liability for expenses, such a salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and, thus, does not constitute a significant economic risk to support treatment as an independent contractor. 

17. Working for more than one firm at a time. If a worker performs more than de minimis services for a multiple of unrelated persons or organizations at the same time, that factor generally indicates that the worker is an independent contractor. However, a worker who performs services for more than one person may be an employee of each of those persons, especially where such persons are part of the same service arrangement. 

18. Making services available to general public. The fact that a worker makes his or services available to the general public on a regular and consistent basis indicates an independent contractor relationship. 

19. Right to discharge. The right to discharge a worker is a factor indicating that the worker is an employee. An employee is often controlled through the threat of dismissal, and therefore obeys the employer's instructions. An independent contractor, on the other hand, cannot be "fired" so long as he or she produces a result that meets the contract specifications.

 Right to terminate. If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship.

 In addition to applying this test, the ultimate determination of an employee's classification will rest on whether an employer has the right to direct and control the means and details of the work performed.2

 Managerial personnel are considered employees. A member of the board of directors of an organization, in his or her capacity as such, is not an employee of the organization. 

An independent contractor is considered self-employed and the company for whom services are provided need not comply with the tax rules on the independent contractor's behalf.3 For federal tax purposes, the three separate employment tax schemes (i.e., income tax withholding, social security and Medicare taxes ("FICA")) and employment tax ("FUTA") do not apply if the worker is properly classified as an independent contractor.  For example, the employer is not required to obtain the Form W-4 from the worker, provide a Form W-2 to the worker and the Social Security Administration (with the transmittal Form W-3), or include payments with respect to the worker in the quarterly filed Form 941 with the IRS. The employer's sole responsibility is to file Form 1099-Misc, except in certain limited circumstances, documenting the amount of payment made to the independent contractor. The remainder of the tax responsibilities is shifted to the worker. 

Various types of employment taxes and withholding obligations imposed at the New York State level are also based on the existence of an employee relationship and do not relate to independent contractors.4