Economic Realities Test

Employee or Independent Contractor?

"Independent contractors, by definition, are self-employed and because they are not employees, independent contractors are not covered by employment, labor, and related tax laws. Employers may be tempted to reclassify employees as independent contractors in order to avoid taxes, benefits, and other liability. Whether or not a worker is covered by a particular employment, labor, or tax law hinges on the definition of an employee." (Department of Labor)

Whether a worker is an employee or an independent contractor depends on the nature of the employment relationship. The “economic realities” test must be applied by employers to determine the nature of their relationship with their workers under the Fair Labor Standards Act (FSLA). Under that test, employers must consider the following factors when determining whether a worker meets the statute’s definition of “employee”:

• The extent to which the services rendered are an integral part of the employer’s business;
• The permanency of the relationship;
• The amount of the worker’s investment in facilities and equipment;
• The nature and degree of control by the employer;
• The worker’s opportunities for profit and loss;
• The amount of initiative, judgment, or foresight in open market competition with others required for the worker’s success; and
• The degree of the worker’s independent business organization and operation.

The DOL cites the IRS's so-called “20-factor test,” in which it assesses the degree of control the company exercises over the way the work is performed by the independent contractor. If the company exercises too much control, the worker is deemed to be an employee. Employers do not have to pay FICA (social security and Medicare) and FUTA (federal unemployment insurance) taxes on independent contractors, nor do they have to withhold federal income taxes for these individuals. The IRS, which estimates that it loses billions in tax revenue each year due to misclassification of employees as independent contractors, has cracked down on the problem in recent years.

For the original article on the definition, see the DOL's article:
• Who Is an Employee? Determining Independent Contractor Status