As the so-called “gig-economy” grows and businesses rely more on freelance or temp workers, an issue businesses continue to grapple with is whether to classify those workers as independent contractors or employees. The distinction has significant consequences for workers and businesses alike. For instance, if a worker is deemed an employee, the employer must withhold and deposit income taxes, Social Security and Medicare taxes, as well as pay unemployment taxes and carry worker’s compensation insurance. Misclassifying workers can also expose a business to state and federal penalties and back-taxes. This article will outline key areas where worker classification is important and identify factors that bear on whether a worker is an employee or an independent contractor.
Worker Classification Under Minnesota Law
Traditionally, Minnesota courts have relied on a five-factor test to determine whether an individual is an employee or an independent contractor. These factors are:
- The right to control the means and manner of performance
- The mode of payment
- The furnishing of tools and materials
- Control over the premises where the work is done
- The right to discharge
Guhlke v. Roberts Truck Lines, 128 N.W.2d 324 (1964). The degree of control a business exerts over a worker is the primary factor considered. Hunter v. Crawford Door Sales, 501 N.W.2d 623 (1993). While an employer controls an employee’s job duties, independent contractors generally have the discretion to complete work in whatever manner they choose. When examining the “control” factor, the following considerations may be helpful to keep in mind:
- Can the worker choose when, where and how work is completed?
- Has the worker received specific training by the employer?
- Must the worker perform work personally or can she freely hire a substitute?
- Is there a continuous, ongoing relationship or temporary and sporadic work?
- Is the worker permitted to work for others while engaged in work for an employer?
- Is the worker required to routinely report to the employer?
- Does the worker pay for his or her own business and travel expenses?
- Is the worker in a position to realize a profit or loss on a project?
Once the level of control is taken into consideration the four remaining common law factors are given weight in the worker classification determination.
Beyond the traditional factors above, Minnesota statutes and administrative rules also provide occupation-specific criteria for asserting employee or independent contractor status for purposes of worker’s compensation coverage. For example, Minnesota Statute § 181.723 sets out nine factors for a construction worker to qualify as an independent contractor. Minnesota Rules Chapter 5224 also contains worker classification guidelines established by the Department of Labor and Industry for 34 specific occupations, ranging from barbers and babysitters to doctors and timber fellers. See Minnesota Rules, Parts 5224.0020 through 5224.0312. If all of the criteria for a specific occupation are not met, Minnesota Rule 5224.0320 further provides additional general criteria to evaluate whether a worker is an employee or an independent contractor. Other state agencies, like the Minnesota Department of Revenue and the Department of Employment and Economic Development also have their own rules and tests governing whether a worker is an independent contractor or employee. Recognizing that the applicable worker classification standard under state law may vary based on occupation or context, it is always advisable to consult with a legal professional if there is uncertainty regarding how to classify workers.
IRS Worker Classification Considerations
Classifying a worker as an employee versus as an independent contractor also has significant federal tax implications. As noted, if a worker is an employee, the employer is required to withhold federal income taxes, as well as Social Security and Medicare taxes. If a business “misclassifies” a worker and fails to properly withhold or pay the required taxes, the Internal Revenue Service (“IRS”) may flag the business and come after any amounts owed.
The IRS has also identified several factors it considers when determining whether a worker is an employee or an independent contractor, and again, a major focus is the degree and type of control a business exerts over the worker.
- Behavior Control
This factor focuses on the degree to which a business exercises control over how and when work is completed. Also relevant is whether a business trained the worker or provided tools or equipment. The more control a business has over those aspects of a job, the more likely the worker is an employee.
- Financial Control
Under this factor, the IRS considers things such as whether the worker is paid a salary or guaranteed wages, or instead paid a flat fee per project. Also, under this factor, independent contractors tend to have made a significant investment in their business, acquiring equipment, training and/or licensing, and are not reimbursed for expenses like tools, fuel or supplies.
- Type of Relationship
Under this factor, if a worker provides services directly related to a business’s core work or receives benefits like sick time and health insurance, this is consistent with being an employee. The concept of permanency is also important, as independent contractors are usually brought in on a short-term basis, to work on discrete jobs.
If the IRS suspects a business has misclassified workers, it may request that the business complete a Form SS-8, entitled “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding,” which it uses to make a worker classification determination. The IRS does have a safe harbor provision, Section 530, which permits an employer to forego paying employment taxes for potentially misclassified workers if specific criteria are met. The IRS also has a Voluntary Classification Settlement Program that allows a business to voluntarily reclassify workers as employees for future tax periods in exchange for partial relief from federal employment taxes owed on misclassified workers. Because the rules can be complex and the financial consequences significant, a business should always seek legal counsel if it is forced to engage with the IRS on these issues.
While the line between employee and independent contractor can be blurry, it pays to get it right. The points above should provide insight into what factors may apply when drawing this line, but it is important to be aware that other agencies, like the National Labor Relations Board and U.S. Department of Labor, also have their own criteria and tests. As a result, if questions remain about how to classify workers in a given situation, do not hesitate to seek professional guidance from someone well-versed in the rules.
Richard Hansen is an attorney with Fryberger, Buchanan, Smith & Frederick, P.A., practicing in the area of Litigation, Arbitration, and Appeals. This article is not intended to provide legal advice. You should always consult with an attorney about your specific circumstances.