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Correctly Classifying Your Workers

03/03/2016

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The debate over classifying workers as employees, independent contractors, or freelancers has changed quite a bit since the summer of 2015. After the California Labor Commission ruled that drivers for Uber Technologies, Inc. were true employees, instead of independent contractors, the U.S. Department of Labor decided it was time to get involved with their own 15-page Administrator’s Interpretation (effective July 15, 2015) of the Fair Labor Standards Act (FLSA).

Before the Administrator’s Interpretation, issued by Dr. David Weil, the FLSA’s definitions of worker-types and guidelines associated with each worker-type were quite vague — employee is literally defined as “any individual[s] employed by an employer.” That’s quite an ill-defined term. The Department of Labor issued the Administrator’s Interpretation to clear up the confusion of misclassifying workers, so let’s take a closer look at how it classifies the three types of workers and what distinguishes them from each other.

1. Freelance Workers

Technically, a freelance worker is someone who is hired on a per-project basis. Usually, the freelancer manages multiple projects from different clients and is paid per project (as opposed to hourly). The freelancer reports and withholds their own taxes, and they typically itemize their deductions. Freelancers do not receive employee benefits from the companies they work with. If your team needs some extra help with a big project, a freelance worker is the way to go.

With an increase of over 700,000 over the last year, there are now almost 54 million freelance workers in America. That’s over a third of America’s workforce. Most freelancers choose this option for the flexibility it provides. Being able to work on your own time, move around as you please, and choose the projects you work on are just a few of the benefits that come with being a freelance worker. However, with all the benefits, freelancing does have its downsides. Freelancers do not have access to unemployment insurance, tax withholding, employer-sponsored health care, or retirement savings programs — they have to provide all of these safety precautions for themselves.

2. Independent Contractors

Independent contractors can work similarly to freelancers, but they typically work more with one or two companies for an extended period of time (the contract) and are paid by the hour. Like their freelance peers, independent contractors also report their own taxes and lack unemployment insurance, employer-sponsored health care, retirement savings programs, and paid time off. Independent contractors are typically highly skilled in a particular area, like coding and design, writing, public/media relations, electrical engineering, and marketing. Independent contractors can fill in holes and help round out an already established team. 

3. Employees

An employee is someone outrightly hired by a company for an indefinite period of time. An employee is expected to work a certain number of hours each week (typically 40) in exchange for a salary and benefits, like paid time off and sick leave, matching 401k contributions, and health insurance. Overtime may or may not be required, and may or may not be compensated for, depending on the employment offer. Employment is also specified as at-will, which means that you or the employer can terminate employment at any time for any reason. 

What's Changed?

The biggest changes with the Department of Labor’s (DOL) Administrator’s Interpretation occur with the distinction between employee and independent contractor. The DOL’s new interpretation explains that an “economic realities” test needs to be employed (pun intended) to determine worker classification. For this new test, the key question is to find out whether a worker is economically dependent on an employer, making the worker an employee, versus whether the worker is truly in business for him or herself, making the worker an independent contractor. This test should always be conducted on a case-by-case basis, as each worker’s situation is going to differ from the next. Factors typically include:

  1. the extent to which the work performed is an integral part of the employer’s business
  2. the worker’s opportunity for profit or loss depending on his or her managerial skill
  3. the extent of the relative investments of the employer and the worker
  4. whether the work performed requires special skills and initiative
  5. the permanency of the relationship
  6. the degree of control exercised or retained by the employer 

Determining the right classification for your workers is vital to the success of your business. Not only does the wrong classification have negative effects on workers, like leaving them high and dry with no safety net, but misclassification of employees may result in substantial penalties, fines, and attorney/accounting fees. Determining the correct classification for your workers will save everyone a headache in the long run.