While there is a lot of gray area regarding the difference between employees and independent contractors, the law is quite clear in this regard—independent contractors are not entitled to overtime pay. In fact, employers aren’t required to pay wages or provide benefits to an independent contractor because they aren’t a W-2 employee on payroll. Where the gray area comes into play is with the distinction between an independent contractor and an employee. Unfortunately, it’s not uncommon to see employers deliberately misclassify employees as independent contractors to save money in wages and benefits.
The basis of federal wage law—the Fair Labor Standards Act
The Fair Labor Standards Act (FLSA) was passed in 1938 to put a floor under wages and a ceiling over work hours. This is the federal law that establishes the minimum wage, requires time-and-a-half pay for overtime wages, and imposes recordkeeping requirements that hold employers accountable for tracking their employees’ wages and time worked. In contrast to many other federal employment laws that only apply to employers with 15 or more employees, the FLSA covers any business that engages in inter-state commerce. That includes any business that deals with customers or prospective customers in multiple states, or that order product or materials from out-of-state.
The important thing to remember with the FLSA is that it only applies to employees, not independent contractors. According to the FLSA, an employee is one who follows the “usual path of an employee and is dependent on the business which he or she serves” (WHD Fact Sheet 13). In contrast, an independent contractor is someone who is engaged in their own business and works with the employer on a contractual basis. As such, the employer-employee relationship applicable under the FLSA is defined by “economic reality,” not by any technical concepts or common law standards.
Common problems with the FLSA
There are a number of problems that can arise from the ambiguity of the employee-employer relationship under the FLSA:
- Employers may hire independent contractors who should be classified as employees (known as misclassification)
- Franchisors may classify franchisees as independent contractors when they should be classified as employees
- Volunteers who perform the same work as paid employees should be classified as employees
- Interns and trainees who take part in unpaid internships or training and perform the same work as paid employees, and therefore should be classified as an employee
- Individuals who work from home often consider themselves independent contractors, when their work for the company should qualify them to be employees
The economic reality test
As is often the case with ambiguous legislation, the courts have had to step in and provide direction on the matter. While the US Supreme Court has indicated that there isn’t a single rule or test for distinguishing between independent contractors and employees, the court has held that the total activity and/or situation controls the distinction. In that regard, some of the important factors that can influence the distinction include:
- The extent to which the individual’s activities are an integral part of the employer’s business
- The permanency of the employer-employee relationship
- The amount of the individual’s investment in facilities and equipment in regard to the work performed for the employer
- The extent to which the employer can exercise control over the individual
- The individual’s potential for profit and loss
- The amount of foresight, judgement, and initiative in open market competition with other businesses that is required for the individual’s success
- The degree to which the individual’s organization and operation are independent from the employer’s
The courts have also determined that there are certain factors which are immaterial in defining the employer-employee relationship. Such factors include whether the individual is a licensed contractor, the absence of a formal employment agreement, where the individual performs their work, the mode of payment, and the timing of payment.
The IRS 20-factor test
The IRS test is usually referred to as the “right-to-control” test because each question is designed to assess who controls the work performed. Generally speaking, independent contractors will have more control over how, where, when, and by whom the work is performed. That said, an individual doesn’t need to satisfy all 20 questions to qualify as an employee. Every case is different and will need to be analyzed on a case-by-case basis.
The 20 factors proposed by the IRS to evaluate independent contractors versus employees include:
- Amount of training – does the business require mandatory company-provided training?
- Assistants – does the company hire, supervise, and pay an assistant for the worker, or does the worker retain control over their assistants and helpers?
- Availability to the public – are the worker’s services regularly available to the public, or are they exclusively for the company?
- Business integration – to what extent are the worker’s services an integral part of the business’s operations? Do the services significantly affect the success of the business?
- Business/Travel expenses – does the worker bear the cost of travel and/or business expenses, or is the worker reimbursed for travel and business costs?
- Continuity of the relationship – is the worker-employer relationship continuous? If the relationship is ongoing, is the arrangement for multiple, sequential projects?
- Control over discharge – does the company have a unilateral right to discharge the worker?
- Flexibility of schedule – does the company dictate the worker’s hours or days worked?
- Full-time work – does the worker perform services for the employer full-time?
- Investment in facilities – does the worker invest in and maintain his or her own work facilities?
- Level of instruction – to what degree is the company able to direct where, when, and how work is performed?
- On-site services – does the company require the worker to provide their services on the company premises? If so, is it possible for the work to be performed off-site?
- Payment – are paychecks issued on a set schedule? If so, is the schedule in sync with how the company pays its W-2 employees, or is it just a matter of convenience? Are payments made on commission or project completion?
- Personal services – can the company insist that a particular person performs the work in question, or is the worker free to assign the work to anyone?
- Provision of materials and tools – does the worker provide their services using company-provided materials, tools, and equipment?
- Realization of profit and loss – does the worker receive predetermined earnings? Does the worker have any chance to realize significant profits or losses?
- Reports – is the worker required to provide regular written or oral reports on the status of their projects?
- Right of termination – does the worker have a unilateral right to terminate their work for the company without liability?
- Sequence of work – does the company control the specific order or sequence in which work is performed?
- Working for multiple companies – does the worker simultaneously provide services for multiple unrelated companies?
Need Help With An Employment Law Issue?
The state of Arizona is a great place to live and work, but knowing the employment laws will help you a lot. Whether you are a newcomer to the state or a lifelong resident, understanding your workplace protections is good for your career, and the more you know, the better.
Employment law issues can cause extreme distress and can affect productivity on the job. If you are being harassed at work, or dealing with any other employment issue, consider talking to our AZ employment law team to help you settle your case.
Call our Employment Law team at (480) 464-1111 to discuss your case today.