The evolving role of independent contractors in the U.S. workplace

January 30, 2023 - Few issues are likely to evoke more divergent views from employment lawyers than the role and classification of independent contractors in the U.S. workplace. This is for a host reasons, but in large part is due to the evolving legal standard for when and under what circumstances U.S. businesses can properly classify workers as contractors.

It is also due to the fact that the consequences of misclassifying a worker as an independent contractor — which potentially range from unpaid wages and tax contributions to civil penalties and liquidated damages — can be significant, particularly for businesses that utilize a substantial number of contractors.

In this article, we will discuss the traditional independent contractor model, how that model and the corresponding legal standard for assessing contractor classification is evolving in the U.S., and best practices for businesses seeking to minimize their liability on this front.

Background: What is an independent contractor?

Broadly speaking, a U.S. worker can be classified as either an employee (an individual to whom statutory wage payment and other legal protections apply) or an independent contractor (to whom such protections generally do not apply).

Although the vast majority of the U.S. workforce falls into the former category, independent contractors serve an important function in the economy and offer businesses many benefits. To take advantage of these benefits without risking the downsides, including "misclassification" litigation and other pitfalls, however, it is important for companies to understand the differences between employees and independent contractors from a legal standpoint.

Typically, companies engage independent contractors for a discrete period of time to perform a task or series of tasks outside the scope of expertise of the regular, employee-workforce. And unlike employees, contractors generally are not asked to complete employment applications or W-4 forms, and do not receive the company's employee handbook.

In addition, independent contractors usually remain free from direct supervision and control, can negotiate their own pay rates, retain latitude to perform their assigned task(s) in any manner and on any schedule they choose (so long as their work product is delivered by company-required deadlines), and are permitted to contemporaneously perform work for multiple businesses, including competitors.

If properly implemented, an independent contractor relationship can be mutually beneficial. For the independent contractor, the relationship offers greater flexibility and control over one's work, along with tax benefits. For the engaging company, one benefit is that the costs of independent contractor engagement generally pale in comparison with those associated with employee hiring and retention. For instance, the company is not required to contribute to unemployment insurance funds, provide expensive benefits, or allow participation in retirement, profit sharing, and similar plans.

How to determine if a worker is properly classified an independent contractor

While the benefits of independent contractor relationships are substantial, the consequences of misclassifying employees as independent contractors can be steep. Unfortunately, determining whether a worker is properly classified as an independent contractor as opposed to an employee is not as simple as it may sound.

Until somewhat recently, whether a worker was properly classified as an independent contractor was generally determined by a common law right-to-control test. Under this test, if an individual had control over key aspects of the work being performed, then it was more likely that they were properly classified an independent contractor.

On the other hand, if the company controlled key aspects of the work — such as the nature of the work, work location and tools, schedule, and aspects of termination — it was usually likelier that the individual should have been classified an employee.

In recent years, however, a smattering of disparate independent contractor classification tests have emerged — due primarily to new state laws and evolving standards used by government agencies to assess classification issues — thereby putting additional requirements in play and creating greater uncertainty.

Perhaps most notably, in 2019, California adopted the so-called ABC test to determine misclassification issues. This extremely employee-friendly standard presumes that workers are employees and only considers a worker to be an independent contractor if the putative employer can establish that the following three factors warrant such a conclusion: (A) the degree of control that a company places on a worker; (B) work must be performed outside the usual course of the company's business (or, in some cases, outside the company's place of business); and (C) the worker typically provides this type of work as an independent business from the company.

Other states, such as New Jersey, Massachusetts, and Connecticut, have adopted some iteration of the ABC test and several more, including Nevada, Oregon, and Washington, are considering doing the same.

And even within a single state, a company may have to consider multiple tests. For instance, in Pennsylvania, there are at least four tests that could apply depending on the issue. The common law control test, for example, applies under the Pennsylvania Workers' Compensation Act. On the other hand, courts apply the first and third factors of the ABC test under the Pennsylvania Unemployment Compensation Law. Further still, under the Pennsylvania Construction Workplace Misclassification Act, construction workers may be considered independent contractors only if a series of eight requirements is met. And Pennsylvania is not unique in this regard.

Changes have also taken place at the federal level. The U.S. Department of Labor (DOL), for instance, has gone back and forth on the appropriate test in recent years. To that end, the DOL has long applied a broader test, the economic realities test, when assessing status as it pertains to the Fair Labor Standards Act. The economic-realities test is a totality-of-the-circumstances analysis that weighs right to control but also the overall economic dependence of the worker on the company.

But in 2021, the DOL implemented a rule that rejected the economic-realities test and implemented a more lax standard that relied on two factors as most important for independent contractor classification: (1) the control over the work and (2) the presence of the opportunity for profit and loss. Since then, however, the DOL has issued a proposed rule to revert back to the economic realities test.

Due to the above-described recent changes and proposals, properly classifying a worker as an independent contractor is generally far less certain than it was just a few decades ago.

How to best protect your organization

To maximize the likelihood that your contractors are properly classified, it is important to contact counsel experienced with these issues, but a general framework to follow when considering independent contractor treatment follows.

(1) Identify the applicable test or tests at play. It is important to know what factors will be considered in the event a worker's independent contractor status is scrutinized by a court or regulatory body. Businesses should be mindful that the landscape is ever-changing, however, and adjust relationships as needed based on changes to the law or attendant regulations.

(2) Cater any independent contractor relationship to the strictest test possible in the applicable jurisdiction. Ensure that as many factors are met as possible (or all in the cases like the ABC test, under which the factors are more like requirements). Most crucially, leave as many details about the work to be performed within the control of the contractor.

(3) Be realistic about the nature of your working relationships. Do not allow the benefits of independent contractor designation to cloud an honest evaluation of the propriety of such designation. In borderline cases, consider erring on the side of employee — rather than independent contractor — designation; doing so will often prove more beneficial in the long run.

(4) Document all terms and conditions of the relationship and interactions. It will be critical in any lawsuit or administrative proceeding to be able to produce concrete evidence that caters to the relevant factors. Communicate via email or other written medium when possible. Memorialize notes and results of oral conversations.

(5) Don't assume that your contract will save you. One of the more common myths shrouding the independent contractor relationship is that a written agreement that officially labels a worker as an independent contractor, rather than an employee, will shield a company from misclassification liability. That assumption is incorrect. Indeed, it is not the contractual label, but rather the actual relationship between the worker and the engaging entity, that controls.

(6) Don't sleep on the risks of misclassification. Misclassifying an employee as an independent contractor can have severe consequences, including on the wage/hour, tax, benefits, and insurance (e.g., workers' compensation, unemployment, disability) fronts, among others. In New York, for example, businesses are subject to a $2,000 fine for every 10 days that they did not carry workers' compensation insurance on a misclassified contractor. Additionally, for businesses that utilize more than a handful of contractors, there is the additional risk of potential misclassification claims being brought on a class and collective action basis.

It is likely that independent contractor issues will continue to evolve at the federal and state levels in the coming years. In addition to evaluating current independent contractor relationships in light of applicable tests, companies must remain plugged in to the changes and adapt as those changes come.

Mark S. Goldstein is a regular contributing columnist on labor and employment for Reuters Legal News and Westlaw Today.