Why Calling an Employee an "Independent Contractor" Doesn’t Make It So: Understanding the Real Test for Worker Classification

Many businesses are turning to independent contractors to meet their needs in today's flexible workforce. Independent contractors offer a way to avoid the administrative and financial burdens associated with employees, such as payroll taxes, benefits, and overtime pay. However, simply labeling a worker as an "independent contractor" does not automatically make it true. Both state and federal laws impose strict criteria for determining whether a worker is truly an independent contractor or, in fact, an employee.

Misclassifying employees as independent contractors can lead to serious legal consequences, including back taxes, penalties, and legal claims. The following explores why simply calling someone an independent contractor doesn’t ensure they are one—and the key factors businesses must consider to classify workers properly.

The Label Doesn’t Matter—The Law Does

Many businesses make the mistake of assuming that by signing an agreement and using the title "independent contractor," they are free from employment laws and tax obligations. However, courts and government agencies consistently emphasize that the label is irrelevant if the working relationship resembles an employer-employee's.

The substance of the relationship is what counts, not the name on the contract.

Courts and enforcement agencies focus on how the work is performed, who controls it, and the degree of independence of the worker.

A written contract calling a worker an independent contractor is only one piece of evidence. It is not determinative of the worker’s status under the law.

How Independent Contractors Are Truly Defined

Different tests determine whether a worker is an employee or an independent contractor. The most commonly used criteria include the "right to control" test, the "economic realities" test, and, in some states, the ABC test. These tests look at several factors related to control, independence, and the nature of the relationship.

The Right to Control 00

This test is applied in many jurisdictions, including Ohio, and focuses on the degree of control the employer exercises over the worker.

• If the company dictates the methods and processes, the worker is likely an employee.

• An independent contractor generally controls when and how they complete their work.

• Independent contractors typically use their tools and equipment.

The Economic Realities Test

Under the Fair Labor Standards Act (FLSA), the economic realities test assesses whether a worker is economically dependent on the employer. If so, the worker is likely an employee.

• Independent contractors can experience financial risks or rewards based on their business decisions.

• A long-term, continuous relationship suggests an employee-employer relationship.

The ABC Test

Some states use this stricter test, which presumes a worker is an employee unless the business can prove:

• The worker is free from the control and direction of the company.

• The work performed is outside the company’s usual business.

• The worker is engaged in an independently established trade or business.

A worker's classification depends on the actual working conditions and the level of control exercised by the business, not the title given to the worker.

Consequences of Misclassification

Misclassifying an employee as an independent contractor, even unintentionally, can have severe legal and financial consequences. This is why it's essential to look beyond the label and focus on how the working relationship functions.

Tax Penalties

If the IRS determines that a worker was misclassified, the employer may be liable for unpaid payroll taxes, including Social Security and Medicare contributions, penalties, and interest.

Wage and Hour Claims

Under the Fair Labor Standards Act (FLSA), independent contractors are not entitled to minimum wage, overtime, or benefits. However, if a misclassified worker brings a claim, businesses may be liable for back wages, overtime, and other employee benefits they should have received.

Workers' Compensation and Unemployment Insurance

Misclassified employees may also be entitled to workers' compensation benefits and unemployment insurance, which independent contractors are not typically eligible for. The business could face penalties for not providing these benefits.

Critical Questions to Assess the True Relationship

To avoid misclassification, businesses should ask the following questions to assess whether a worker is truly an independent contractor:

Does the Worker Control How the Work Is Done?

Independent contractors should have control over how they complete their work, including the tools and methods used. The worker is likely an employee if the company dictates specific procedures or closely supervises the work.

Can the Worker Reject or Accept Work?

Independent contractors should be free to choose when and for whom they work. On the other hand, employees are typically required to perform work assigned by their employer.

Does the Worker Have an Independent Business?

Independent contractors usually have their own businesses, offer services to multiple clients, and market their services to the public. If the worker depends on one company for their income, this suggests they are an employee.

Is the Work Central to the Company’s Business?

If the worker’s duties are essential to the company’s main business (for example, a chef at a restaurant), they are more likely to be classified as an employee. Independent contractors typically perform work outside of the core functions of the company.

Steps to Avoid Misclassification

To ensure you correctly classify your workers, follow these steps:

Analyze the Working Relationship

Before hiring a worker as an independent contractor, assess the relationship against the various classification tests. Focus on the degree of control, the worker’s independence, and the nature of the work.

Use Detailed Contracts

Ensure the independent contractor agreement reflects the worker's true independence. While the contract alone won’t determine the worker’s status, aligning with the relationship's reality is essential.

Avoid Controlling Behaviors

Refrain from micromanaging independent contractors. Do not impose specific working hours, dictate their methods, or integrate them too closely into your company’s operations.

Seek Legal Advice

Consult with legal counsel if you need clarification on whether a worker should be classified as an employee or independent contractor. Misclassification can be costly, and laws frequently change in response to gig economy issues.

Summary

Simply calling a worker an independent contractor doesn’t make them one in the eyes of the law. The actual working relationship, including the level of control, independence, and the nature of the work, determines the classification. Misclassifying workers can result in costly legal consequences, including back pay, taxes, and penalties. To avoid these risks, businesses must carefully evaluate their workers using the appropriate legal tests and consult legal counsel when in doubt. Proper classification is not just about avoiding penalties—it’s about ensuring fairness and compliance in your business practices.

Christopher M. White Executive Partner EQUES® Law Group