Employee vs. Contractor Classification
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The proper classification of farm labor is also important to comply with tax law, unemployment insurance law, and the requirements of overtime as required by FSLA. This concerns a farm employer’s choice to classify farm labor as an “employee” or a “contractor.” The distinction is critical regarding an employer’s obligation under federal and state income tax law to withhold income for federal and state taxes,[i] and pay sundry “self-employment” taxes for federal social security contribution tax[ii], and federal and state unemployment taxes.[iii] Such withholdings and payments are required of employers paying regular wages. For other labor classified as “contract labor,” such withholdings are not required and are left to the payment responsibility of the contractor. A not uncommon mistake is for employers to hire labor as “contractors” to avoid paying self-employment taxes. Because the classification has tax, FLSA and Workers’ Compensation exemption implications, the penalty for misclassification can be severe.
Factors Determining Status
Generally, the common law holds that anyone who performs services for another is their employee if the latter can control what will be done and how it will be done. The United States Supreme Court applied an “economic reality” test to the relationship, holding that a worker is an employee where he or she is economically dependent on the entity to whom he or she renders labor or services.[iv] In addition to the definitions of employer and employee provided above in discussion of FLSA, the Internal Revenue Service provides guidance on the factors that determine whether labor can safely be hired on independent contract. Such factors indicating an employment relationship are:
- The extent to which the business – exchange for paying wages – has the power to direct and control the work performed by the worker, even when that power is not exercised. Factors include direction on when and where to work, whether tools for the work are provided to the worker or directives on what tools to use, or where to purchase supplies and services.
- The level of detail in instructing a worker how to perform a task, including training on how to perform a task, and evaluation of the worker’s performance in completing the task
- The balance of financial control in the relationship, such as: does the worker have an opportunity to make a profit or loss from the relationship? Is the worker free to perform services for other participants in the marketplace? Does the compensation directly relate to the amount of time (e.g. monthly, weekly, hourly) spent working, rather than a flat fee?
- The nature of the working relationship itself, such as: has the worker been given an end date to the performance of service, or is there an expectation that the relationship will continue indefinitely? Is the nature of the work critical to the business paying compensation to the worker, i.e. is the work critical to the businesses performing its own economic contribution to the marketplace?
While it is always a good idea to have a written employment agreement or contract for an independent contractor, language in the contract specifying that the worker is an “independent contractor” is not relevant to the determination.[v]
As noted above, the penalties for misclassification can be severe on the employer. Such penalties include fines and penalties under FLSA, including back pay of missed overtime and in some cases criminal penalties, as well as back payment with interest on missed tax withholdings.[vi]
[i] 26 U.S.C. §3402(a)(1)
[ii] 26 U.S.C. §3102(a)
[iii] See 26 U.S.C §3301 et seq. and N.C.G.S §96-1 et seq. These payroll taxes are referred to as FUTA and SUTA respectively.
[iv] See Rutherford Food Corp. v. McComb, 331 U.S. 722, 726–28, 3. See 29 U.S.C. § 203(g). 730 (1947)
[v] See generally Understanding Employee vs. Contractor Designation (IRS)
[vi] For a thorough discussion of the employee vs. contractor issue, see Jufrass, Diane, Independent Contractor or Employee? The Legal Distinction and Its Consequences, UNC School of Government (2009)
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