Independent Contractor Toolkit
Resources to help companies comply with the legal requirements associated with engaging independent contractors, including information to help them avoid misclassification.
Because independent contractors ( www.practicallaw.com/6-502-8864) are not employees, companies that use independent contractors instead of (or in addition to) employees benefit in many ways. For example, employers must pay taxes, make appropriate withholdings, and obtain insurance coverage on behalf of employees. Because those requirements generally do not extend to independent contractors, companies can avoid certain tax and insurance obligations by contracting with them.
In addition, because employee benefits, such as paid vacation and retirement plans, are often not provided to independent contractors, companies avoid the expense of those benefits by engaging independent contractors. Companies can also alleviate the compliance burden associated with employment and immigration laws that cover employees but not independent contractors, including:
Form I-9 ( www.practicallaw.com/6-502-1061) requirements under the Immigration Reform and Control Act ( www.practicallaw.com/7-504-5735) (IRCA).
Also, a company's coverage and some penalty calculations under the Affordable Care Act ( www.practicallaw.com/6-505-8403) (ACA) are based on the employment status of individual workers.
Proper classification of individuals as independent contractors is not as simple as a written agreement with the purported contractor. No single test exists to evaluate independent contractor status for all purposes. Courts assess independent contractor status under a variety of statutes, including state and federal tax, employment discrimination, and employee benefits laws. Potentially applicable tests include:
The economic realities test, used to determine independent contractor status under the Fair Labor Standards Act ( www.practicallaw.com/5-501-9884) (FLSA).
The Internal Revenue Service's ( www.practicallaw.com/0-382-3556) (IRS) three-category standard for federal tax purposes.
The common law 20-factor test, frequently cited by states for employee classification purposes.
The common law Darden test, which is generally used for Title VII, Americans with Disabilities Act ( www.practicallaw.com/7-501-9331) (ADA), Age Discrimination in Employment Act ( www.practicallaw.com/2-501-7061) (ADEA), and Employee Retirement Income Security Act ( www.practicallaw.com/0-382-3434) (ERISA) purposes.
A hybrid test that combines the Darden test and the economic realities test is used by some courts to determine independent contractor status under Title VII and the ADEA.
Various state tests, such as the ABC test used in New Jersey and Connecticut, that can impose a more narrow definition of independent contractor than federal tests.
The consequences of misclassifying individuals as independent contractors can be serious. Because an independent contractor avoids many of the tax and other employment law requirements of an employment relationship, the Department of Labor ( www.practicallaw.com/2-501-6354) (DOL), the IRS, state agencies, and courts construe independent contractor status narrowly and impose large penalties for improper classification. Companies that misclassify employees as independent contractors can be liable for:
Back pay ( www.practicallaw.com/w-001-6458) , including unpaid overtime compensation ( www.practicallaw.com/2-507-1821) under the FLSA (and state equivalents).
Tax and insurance obligations, including Federal Insurance Contributions Act ( www.practicallaw.com/6-502-7586) (FICA), Federal Unemployment Tax Act ( www.practicallaw.com/6-502-7586) (FUTA), and workers' compensation ( www.practicallaw.com/6-502-7586) .
Employment law compliance, including reasonable accommodations ( www.practicallaw.com/7-504-1921) under the ADA and leave under the FMLA.
The value of employee benefits the individual would have been entitled to had they been properly classified as an employee.
Exemplary damages, including liquidated damages under the FLSA.
Companies that have (or suspect they have) misclassified individuals as independent contractors have several options to mitigate their potential liability, including:
The safe harbor created by Section 530 of the Revenue Act of 1978, which protects companies from tax consequences if the companies satisfy the relief requirements.
Liability reduction assistance available under Section 3509 of the Internal Revenue Code (IRC).
The Voluntary Classification Settlement Program (VCSP) offered by the IRS to qualifying companies.
Both the benefits of engaging independent contractors and the consequences of misclassifying them can be significant. This Toolkit includes resources on best practices for engaging independent contractors and avoiding misclassification.