Is your worker an employee or an independent contractor? The question has complicated labor issues on both the state level and federal government in recent years. Consequently, the US Department of Labor is currently rethinking its federal laws. Meanwhile, several state independent contractor laws are being modified in 2021 to better define the difference between the worker classifications.
It’s important to know how to determine if a worker falls under the independent contractor status. However, according to the Economic Policy Institute, an estimated 10-15% of employers misclassify at least one worker as an independent contractor.
Making that mistake can lead to severe penalties, so how do you avoid it? There are two different ways states determine worker classification: The common law test and the ABC test.
Independent contractor common law test
The common law test is used by the IRS for employment tax purposes. Additionally, 18 states and the District of Columbia use it as their law. (Check out the full list below.) This test looks at different types of control an employer could have to determine whether a worker is a W-2 employee or a 1099 contractor.
If any of the following controls are involved, the worker is considered an employee, and you are not engaged in an independent contractor relationship.
If you dictate how a worker performs work, behavioral control is in play. Controlling how an employee performs can include where they work, when they work, and how they get the job done.
The IRS poses this question to help determine behavioral control:
“Does the company control or have the right to control what the worker does and how the worker does his or her job?”
Financial control is evident if you rightfully control your worker’s finances in any way. According to the IRS, financial control includes the following aspects:
- Controlling how the worker is paid for work performed
- Deciding if expenses are reimbursed
- Your employee’s ability to experience profit and loss
- Providing your employee with tools and supplies
This factor looks at how your working relationship with the employee operates. There are several ways to determine if the relationship is in fact an employer-employee situation:
- Are there written contracts or benefits that are usually offered to employees (like insurance, pension plan, paid leave)?
- Is the employment relationship going to continue on a long-term basis?
- Is the worker’s job a key aspect of business operations?
Here’s an example of the last question: If a restaurant hires someone to paint the exterior of their building, that worker is considered to be hired as an independent contractor because the restaurant isn’t in the business of painting.
The independent contractor ABC test
The US Department of Labor uses the ABC test to determine independent contractor status for labor law purposes, including minimum wages, overtime, and workers’ compensation. Also, 33 states use the test.
This test is similar to the common law test in that it looks at the degree of control and the nature of the work. It also examines whether or not the worker is customarily engaged in independent contractor work related to the job they are performing for a business.
A worker is presumed to be an employee unless they meet the following criteria.
Absence of control
If the “hiring entity” does not have control and direction over the worker, both under the work contract and in fact, then an absence of control is present.
However, you may be able to set some hours if there are access restrictions that impact the worker’s ability to do their job. Still, you may not direct the worker in any way on how to perform the work.
Independent contractors must perform work that is not part of the usual course of your business. Like the common law test, the painter who was hired by a restaurant to paint the walls would also be considered an independent contractor under this test.
Suppose the worker is customarily engaged in an independently established trade, occupation, or business that is of the same nature as the work they are performing for you. In that case, they are an independent contractor.
However, the Department of Labor also uses an “economic realities” rule that examines exactly how financially dependent the worker is on an employer. If the business provides a big chunk of their income, the DOL might lean more towards employment status.
Independent contractor state law changes (2021)
Many states—and one city—are expanding their independent contractor laws or changing definitions in the new year. Here is a look at what you should be aware of regarding state classification rules for 2021.
Proposition 22, which allows rideshare companies like Uber and Lyft to classify drivers as independent contractors, was approved by voters. Although they are not considered employees, the new law requires that specific labor and wage policies be put in place for app-based drivers, which you can view here.
Meanwhile, the “Save Local Journalism Act” allows newspaper publishers to wait one more year until they are required to classify their newspaper carriers as independent contractors. The extension expires on January 1, 2022.
SB 2296 established a new rule making workers who operate certain vehicles are classified as independent contractors instead of employees effective July 1, 2021.
Louisiana added a definition of “employee” to their existing classification law. The new definition reads:
“An ‘employee’ means an individual who performs services for an employer where there exists a right by the employer to control what work the employee does or how the employee performs his job or where the employer provides the tools and supplies to the employee for the performance of the job.”
The new Freelance Worker Protection Ordinance requires businesses that hire freelance workers as independent contractors to confirm the relationship in writing and pay the independent contractors following what is laid out in the agreement. The requirement goes into effect on January 1, 2021.
HB 1407 makes it illegal to misclassify an employee as an independent contractor under the IRS common law test. The Virginia Department of Taxation is allowed to investigate and impose civil penalties of up to $1,000 for each misclassified employee for the first offense, and up to $5,000 per employee for further offenses.
The new law takes effect on January 1, 2021.
Independent contractor laws by state
As mentioned before, test usage varies among the states. Take a look at the list below to see if your state uses the common law test, the ABC test, or another type of variation.
|State||Independent contractor test|
|Colorado||A&C of ABC Test|
|District of Columbia||Common Law|
|Idaho||A&C of ABC Test|
|Montana||A&C of ABC Test|
|New Hampshire||ABC Test|
|New Jersey||ABC Test|
|New Mexico||ABC Test|
|New York||Common Law|
|North Carolina||Common Law|
|North Dakota||Common Law|
|Oklahoma||A&B or A&C of ABC Test|
|Pennsylvania||A&C of ABC Test|
|Puerto Rico||ABC Test|
|Rhode Island||ABC Test|
|South Carolina||Common Law|
|South Dakota||Common Law|
|Virginia||A&B or A&C of ABC Test|
|West Virginia||ABC Test|
|Wisconsin||A&C of ABC Test|
|Wyoming||A&C of ABC Test|
Need help applying these employment laws to your small business?
Check out our HR and Compliance services to see how Homebase can help you understand and make it easier to follow state and federal employment legislation.