Ever discovered a misclassification at the time of a work comp audit? If workers get misclassified as independent contractors, consequences will occur when they are determined as uninsured employees. However, because there is not one single test to evaluate independent contractor status for all purposes, employers may face complexity in their compliance efforts. [1]
To sharpen its focus on the gig economy, the DOL instituted tests for verification as a true independent contractor. Further, misclassification can lead to significant liability, because the FLSA requires employers to cater to their W-2s. For example, full-time employees are entitled to various statutory benefits. [2]
“Failure to properly classify workers can result in substantial damages and penalties (even if unintentional)”, including workers’ compensation insurance obligations — our focus here. [3] To avoid these damages and penalties, an attentive risk manager can validate the insurance implications for you, helping to solve the problem. When addressing work comp exposures, the criteria need to have full accuracy before the loss arises; it cannot get corrected after a loss arises with an uninsured team of employees or contractors.
Economic Reality Test, for Independent Contractor vs Employee [4]
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the employer
- Permanence of the work relationship
- Nature and degree of control
- Whether the work performed is integral to the employer’s business
- Skill and initiative. [5]
Therefore, an employer can require a worker to be truly independent, meaning they purchase their own workers’ comp insurance (and General Liability). However, that worker needs to demonstrate clear independent contractor status through one of these six “Economic Reality Tests” established by the DOL.
Match these examples with #1-6 to test your knowledge
A. The Welders
Employee: A highly skilled welder provides welding services for a construction firm. The welder does not make any independent decisions at the job site beyond what it takes to do the work assigned.
Independent contractor: A highly skilled welder provides a specialty welding service, such as custom aluminum welding, for a variety of area construction companies. The welder uses these skills for marketing purposes, to generate new business, and to obtain work from multiple companies. The welder is not only technically skilled, but also uses and markets those skills in a manner that evidences business-like initiative. [6]
B. The Landscapers
Employee: A worker for a landscaping company performs assignments only as decided by the company for its corporate clients. The worker does not independently choose assignments, ask for additional work from other clients, advertise the landscaping services, or try to reduce costs. The worker regularly agrees to work additional hours to earn more money.
Independent contractor: In contrast, a worker provides landscaping services directly to corporate clients. The worker produces their own advertising, negotiates contracts, decides which jobs to perform and when to perform them, and decides when and whether to hire helpers to assist with the work. This worker exercises managerial skill that affects their opportunity for profit or loss. [7]
C. The Cooks
Employee: A cook has prepared meals for an entertainment venue continuously for several years. The cook prepares meals as decided by the venue, depending on the size and specifics of the event. The cook only prepares food for the entertainment venue, which has regularly scheduled events each week.
Independent contractor: A cook has prepared specialty meals occasionally for an entertainment venue over the past three years for certain events. The cook markets their meal preparation services to multiple venues and private individuals and turns down work from the entertainment venue for any reason, including because the cook is too busy with other meal preparation jobs. The cook has a sporadic or project-based nonexclusive relationship with the entertainment venue. [8]
D. The Graphic Designers
Employee: A graphic designer provides design services for a commercial design firm. The firm provides software, a computer, office space, and all the equipment and supplies for the worker. The company invests in marketing and finding clients and maintains a central office from which to manage services. The worker occasionally uses their own preferred drafting tools for certain jobs. In this scenario, the worker’s relatively minor investment in supplies is not capital in nature and does little to further a business beyond completing specific jobs.
Independent contractor: A graphic designer occasionally completes specialty design projects for the same commercial design firm. The graphic designer purchases their own design software, computer, drafting tools, and rents their own space. The graphic designer also spends money to market their services. These types of investments support an independent business and are capital in nature. [9]
E. The Nurses
Employee: A registered nurse provides nursing care for Alpha House, a nursing home. The nursing home sets the work schedule with input from staff regarding their preferences and determines the staff assignments. Alpha House’s policies prohibit nurses from working for other nursing homes while employed with Alpha House to protect its residents. In addition, the nursing staff are supervised by regular check-ins with managers, but nurses generally perform their work without direct supervision. While nurses at Alpha House work without close supervision and can express preferences for their schedule, Alpha House maintains control over when and where a nurse can work and whether a nurse can work for another nursing home.
Independent contractor: Another registered nurse provides specialty movement therapy to residents at Beta House. The nurse maintains a website and was contacted by Beta House to assist its residents. The nurse provides the movement therapy for residents on a schedule agreed upon between the nurse and the resident, without direction or supervision from Beta House, and sets the price for services on the website. In addition, the nurse provides therapy sessions to residents at Beta House as well as other nursing homes in the community at the same time. The specialized services to obtain work for multiple clients, not supervised by Beta House, sets their own prices, and has the flexibility to select a work schedule, all indicate independent contractor status. [10]
F. The Farm
Employee: A large farm grows tomatoes that it sells to distributors. The farm pays workers to pick the tomatoes during the harvest season. Because a necessary part of a tomato farm is picking the tomatoes, the tomato pickers are integral to the company’s business.
Independent contractor: Alternatively, the same farm pays an accountant to provide non-payroll accounting support, including filing its annual tax return. This accounting support is not critical, necessary, or central to the principal business of the farm (farming tomatoes), thus the accountant’s work is not integral to the business. [11]
Answer Key
A. Skill and initiative (#6)
This factor primarily looks at whether the worker uses their own specialized skills together with business planning and effort to perform the work and support or grow a business. The fact that a worker does not use specialized skills (for example, the worker relies on the employer to provide training for the job) indicates that the worker is an employee. [12]
B. Opportunity for profit or loss (#1)
This factor primarily looks at whether a worker can earn profits or suffer losses through their own independent effort and decision making. [13]
C. Permanence of the work relationship (#3)
Nature and length: work that is sporadic or project-based with a fixed ending date (or regularly occurring fixed periods of work), where the worker may make a business decision to take on multiple different jobs indicates independent contractor status. Work that is continuous, does not have a fixed ending date, or may be the worker’s only work relationship indicates employee status. [14]
D. Investments by the worker and the employer (#2)
Does the worker make investments that are capital or entrepreneurial in nature? Investments by a worker that support the growth of a business, including by increasing the number of clients, reducing costs, extending market reach, or increasing sales, weigh in favor of independent contractor status. A lack of such capital or entrepreneurial investments weighs in favor of employee status. [15]
E. Nature and degree of control (#4)
Does the employer control hiring, firing, scheduling, prices, or pay rates, supervise the performance of the work, discipline workers; and takes actions that limit the worker’s ability to work for others? Where the potential employer maintains more control over these aspects of the work relationship, this factor weighs in favor of employee status. [16]
F. Whether the work performed is integral to the employer’s business (#5)
This factor primarily looks at whether the work is critical, necessary, or central to the potential employer’s principal business, which indicates employee status. [17]
Once the employees are determined, the following are included as payroll, as a basis for workers compensation insurance premium: [18]
- Gross wages
- Salaries
- Commissions
- All bonuses
- Most profit sharing
- Vacation, holiday and sick pay
- Overtime (“straight time” portion only)
- The market value of gifts
- Automobile allowances (less reimbursement for documented expenses)
- The following items are excluded from payroll when determining the basis of premium:
- Meals or lodging (unless the classification phraseology specifically includes them or they are provided in lieu of wages)
- Tips
- Premium portion of overtime pay (the increase above the regular rate of pay)
- Severance pay (except for accrued vacation, sick pay, commissions and bonuses)
- Employer contributions to qualified insurance, stock or retirement plans
- Stock options
- The value of an automobile furnished to an employee
- In addition, the following are not included as payroll for premium computation:
- Employee discounts for merchandise
- Residual payments for commercials
- A uniform allowance. [19]
References
[1] – [3]
Brewer, M. E., Burnett, C., & Sharp , A. (2024, April 9). New DOL Rule Makes it Harder to Classify Workers as Independent Contractors (Plus a Quick Recap of the Key Misclassification Standards Across the US). The Employer Report. https://www.theemployerreport.com/2024/04/new-dol-rule-makes-it-harder-for-businesses-to-classify-workers-as-independent-contractors-under-the-flsa-plus-a-quick-reminder-of-the-key-misclassification-standards-across-the-us/
[4] – [17]
Employment relationship under the Fair Labor Standards Act (FLSA). DOL. (n.d.). https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship
[18] – [19]
Payroll or remuneration. WCIRB California. (n.d.). https://www.wcirb.com/research-and-education/online-guide-workers%E2%80%99-compensation/standard-classification-system/payroll-or-remuneration
