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Published Articles by David Balovich

Title: Employee or Independent Contractor?
Published in: Creditworthy News
Date: 1/5/10

We have received several inquiries about hiring or becoming an independent contractor. As businesses continue to look at ways to reduce costs many will consider staffing existing or new positions with independent contractors. Professionals who have lost or may their positions may consider working or continuing as an independent contractor instead of being hired or continuing as an employee. Before looking at this as a method of reducing costs or gaining new or continuing employment it may be prudent for both the employer and/or employee to recognize the requirements for being an independent contractor as failing to do so could create financial consequences that in the long run are not cost effective to the employer or beneficial to the job seeker.

The following is not provided as legal advice but rather information that every employer hiring  an independent contractor or individual thinking of working as an independent contractor should  know. The information provided can be obtained from most state workforce commission offices  or found on their websites.

The first thing one has to understand is that almost all employment laws apply to employees  along with company benefits.  Independent contractors are generally covered only by statutes  limited to discrimination on the basis of race, color, national origin, or citizenship.

The second thing is the majority of states do not have any defined statutes relating to  independent contractors. Instead they have a broadly inclusive test often referred to as  the “direction or control” or “common law” test. Under these tests, “employment” is  defined as a service, including interstate commerce, performed by an individual for wages 
or under an express or implied contract of hire. In order to be classified as an IC it has to  be proved that the individuals’ performance has been and will continue to be free from any  control or direction under the contract. It is important to note that it does not matter that one  or both parties may call their arrangement “contract labor.” The law creates a presumption of  employment and places the burden for proving otherwise squarely on the shoulders of the 
employer. It sets forth the primary factor in a true IC relationship, namely, the absence of  direction and control over the work. To this end back in 1947 the United Sates Supreme Court  established a widely accepted five-part test, known as the “economic reality” test, to help  establish whether a person is an employee or an IC. The five points are: 

The degree of control exercised by the alleged employer; 

The extent of the relative investments of the alleged employee and employer; 

The degree to which the “employee’s” opportunity for profit and loss is determined by the “employer”; 

The skill and initiative required in performing the job; 

The permanency of the relationship. 

Another test, called the “ABC” test, is used by seventy-five percent of all states in determining whether workers are employees or IC’s. In order to be considered an IC most states require  that two out of the three criteria be met, a few states require all three be satisfied. 

The worker is free from control or direction in the performance of the work; The work is done outside the usual course of the company’s business and is performed off the  premises of the business; 

The worker is customarily engaged in an independent trade, occupation, profession, or business. 

Finally, there is the “common sense” test. The “common sense” test says that an employee has nothing to invest in a business beyond the time he puts in and sells his services to only  one “customer”, the employer. On the other hand, an IC is not normally dependent upon only  one customer, but rather, being in business for herself and with an investment in her own  equipment and supplies, has an entire customer base upon which to rely on for her livelihood. 

The importance of these three tests is that the Internal Revenue Service has created another test called the “Eleven Factor” test for determining the coverage of various federal  employment tax laws. The eleven factors test was created using the common law, economic  reality, and ABC tests and represents their various criteria either reorganized or broken  down into more detail. Following are some examples: 

Is the service provided by the individual essential to and an integral part of the  service the employer provides?

 The less able an employer is to offer its primary service without the help of the people whose 
status is at issue the more likely it is that they will be considered employees. The position is that if certain services are essential to a business succeeding or failing based upon how well  those services are performed, the business will naturally want to exercise enough direction  and control over those services to ensure they are good. 

What opportunity for profit or risk of loss is there for the worker?

An employee is paid for her time. She would not be expected to provide her own workplace,  materials, supplies, and tools, or otherwise invest her own money in the business. An employee  who makes a costly mistake can be fired, but cannot legally be forced to work without  compensation. An IC, on the other hand, is an independent businessperson with expense  of his or her own. She will be expected to purchase or provide everything necessary to do 
the job. If he or she fails to satisfy the customer, they would be required to redo the work for  no additional compensation, or face the risk of non-payment by the customer. A true IC’s  main concern is her own bottom line, not that of the employer. Since the IC is responsible for  her own overhead, including the hiring of any help necessary, there is always an element of  negotiation to any bona fide contract for services. Usually, not always, an IC is paid by the  job assignment. It is up to the IC to figure out how much is needed to complete the job as a  profit. If the IC miscalculates, the loss is hers to bear. This creates the opportunity for profit or  loss that an employee does not have to consider. 

Is there a non-competition clause in the agreement? Does the worker provide his  services on a continuous basis?

Generally, non-competition agreements and IC’s do not go hand-in-hand. Such a provision in  a contract is strongly indicative of an employment relationship, chiefly because it proves that the  services in question are directly related to the primary service provided by the employer and not  offered to competitors. If those services were not related, there would be no “competition” and  thus nothing against which to guard. The power to keep a person from pursuing his or her own  business interests and to force a person to sign such an agreement is typical of the power wielded 
by employers over employees. The more long-term, continuous, and exclusive the relationship is,  the more likely it is to be employment. IC’s generally perform their work one job or assignment  at a time and are paid on the same basis. 

Does the individual provide his or her services to the public at large? Are the service  advertised in newspapers, Yellow Pages, web sites, or specialized publications?

If a person holds herself out to the public as self-employed and available for work for any  customer with whom she can negotiate an acceptable price, she is likely to be held an IC.  The more the worker advertises, the more it is apparent they are in business for themselves,  since an independent business survives or fails based upon its business development efforts. 

Cash flow and Rent.

How the money gets from the customer or client to the worker is an important consideration.  If the client pays the employer in general, and the employer pays the worker either by the hour,  by salary, or by commission, the worker looks more like an employee. However, if the employer  pays the contracted price for work completed, the worker appears to be an IC. Alternatively,  if the client pays the worker, and the worker remits an agreed-upon fee or percentage to the  employer, that would look more like an IC then if the worker merely collected from the client 
and passed it along to the employer as an agent would and then receives a share of it back.  Closely related to the cash flow issue is that of the compensation the worker gives the employer  for the use of its facilities or equipment. Remember, the opportunity for profit or loss is an  important element of an IC. An employer normally provides its employees with everything  needed to do their work. A business contracting with an IC normally expects the contractor to  supply what is necessary to accomplish the project. If the worker uses the employer’s facilities 
and/or equipment at no cost, he looks like an employee. 

Hours of Work and Assignments 

When an employer contracts for outside services, they are normally interested only in the end 
result, not in the details of how the IC performs the work. Any worker who is told to work 
certain hours does not have control over their own schedule, an essential component of the 
profit or loss equation, and will normally be considered an employee. The employer should 
have no interest in how the IC allocates his time. If an IC wants to take time off, that should be 
up to the IC not the employer. That is not to say that the contract can not specify that the IC 
will be available within certain guidelines for purposes of consultation or progress checks. 
However, the more control the employer exercises over the hours of the worker, the greater the 
risk is that the arrangement will be considered employment. Closely related to the issues of hours 
of work is that of how the work is assigned to the worker. A worker receiving assignments from 
the employer as they come up is likely to be indistinguishable from a regular employee. An IC, 
having been engaged to perform a specific job or project, derives his “assignments” from the 
terms of the agreement and determines what his hours and daily tasks will be. 

Benefits and Insurance 

An employer who provides benefits such as vacation and sick leave, health insurance, bonuses, 
or severance pay will almost inevitably be considered the employer of the workers. The power 
to award benefits carries with it the power to deny them, and that kind of power is exercised by 
employers. If the employer provides liability insurance for the workers, the workers would likely 
be held to be employees since the workers would not have ordinary business liability as a risk of 
performing their duties. 

Termination of the Relationship 

A business that has the right to fire a worker at will or for cause is generally considered the 
employer of that worker. An IC will normally have some form of contractual recourse if 
terminated before completion of the work, and the contract will generally specify conditions 
that must be met if the contract is to be cancelled by either party. 

These are the main factors to take into consideration when determining whether to hire an 
employee or an IC. It is even more important when considering employment with a firm or 
contracting your services as an IC. 

No one factor will determine an entire situation and not every situation will involve all the factors 
discussed in this article. Each situation should be decided on an individual basis after evaluating 
all of the factors discussed. The bottom line in any situation where the question of employee 
versus independent contractor is at issue is whether the worker in question is in effect an 
independent business entity in a position to make a profit or loss based upon how he or she 
manages their own enterprise.

I wish you well

The information provided above is for educational purposes only and not provided as legal advice. Legal advice should be obtained from a licensed attorney in good standing with the Bar Association and preferably Board Certified in either Creditor Rights or Bankruptcy.  

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