You’ve just started your business – or maybe your business has been thriving for years – and you need more workers to help run the business.  You decide to hire some independent contractors so that you don’t have to worry about the time and costs associated with employee payroll taxes.  Maybe you have heard of the benefits of independent contractors – flexibility, no taxes or benefits owed, no overtime, no employment discrimination risk, no health insurance requirement – and you want to add some independent contractors to your business.  Whatever your situation, you need to make sure the workers you are calling independent contractors are truly independent contractors.  This is because, if you misclassify your employees as independent contractors, your business (and potentially you if your business does not afford you protection from personal liability) can face huge financial penalties.  You can face these penalties regardless of whether you purposefully misclassified your workers.  In recent years, there has been a crackdown by the IRS and other agencies in “catching” businesses that have misclassified their workers.

Determining the Right Classification of your Workers

The general rule is that an individual is an independent contractor if the business has the right to control or direct only the result of the work, not how the individual will complete the work.  So, the payer has the right to tell the individual what the final product should be, not the path the individual should take to get there.  If the payer controls the path to the final result, the individual is not an independent contractor and is instead an employee.

So how can you determine the level of control and therefore the right classification of your workers?  Unfortunately, there is no straightforward answer to this question because there is not a universal test used by courts and governmental agencies to determine the classification of your worker.  There are actually three main tests** used to determine whether your worker is an independent contractor or an employee.

The Main Tests for Determining Proper Classification

Illinois uses a common law test – referred to as the right to control test.  The Fair Labor Standards Act uses the economic reality test.  The Internal Revenue Service uses a test comprised of 20 factors.  All three of these tests should be considered when classifying your worker as an independent contractor.  As you can see the assessment can be a complicated one for this very reason.

Each test answers one question:  How much control does the employer exercise over the activities of the worker?  If the factors of the test below point to a low level of control, the worker can be classified as an independent contractor.  If the level of control is high, the worker is instead an employee and subject to all the taxes and withholding that comes with having an employee.

IRS 20 Factor Test.  The IRS 20 factor test looks at the following factors:

• Whether the worker is required to follow the company’s instructions;
• Whether the company provides training to the worker to accomplish the work
• Whether the worker’s services are integrated into the company’s regular business.
• Whether the company requires that the worker perform the services personally, as opposed to assigning work to others.
• Whether the company hires, supervises and pays the worker’s assistants
• Whether there is a continuing relationship between the company and the worker
• Whether the company sets the worker’s hours
• Whether the company requires the worker to work full-time
• Whether the worker works at the employer’s place of business
• Whether the company sets the order or the sequence of the worker’s work
• Whether the worker is required to provide oral or written status reports to the company
• Whether the worker is paid by the hour, week or month, rather than upon completion of the project.
• Whether the worker is reimbursed for business or travel expenses
• Whether the company provides the employer with tools and materials
• Whether the worker has made a significant investment in performing the services
• Whether the worker can realize a profit or loss
• Whether the worker works for more than one company at a time.  If worker works for more than one company, likely independent contractor.
• Whether the worker makes the services available to the general public
• Whether the company has the unilateral right to discharge the worker.
• Whether the worker has the right to terminate the relationship without being liable under contract.

Illinois Common Law “Right to Control” Test.  Illinois courts look to the following 10 factors:

• The extent of control which, by agreement, the hiring party may exercise over the hired party
• Whether the hired party is engaged in distinct occupation or business that is usually done by a specialist without supervision
• How the worker’s staff are hired and whether they are paid by the hiring party or the worker
• The skill required in a particular occupation
• Which party supplies the means, tools, and place of work
• The length of time for which the person is hired
• The method of payment, whether by time or the job
• Whether the work is part of the regular business of the hiring party
• Whether the parties believe they are creating an employment relationship
• Whether the hired party is an actual business entity

Fair Labor Standards Act “Economic Reality” test.

• The extent to which the work performed is an integral part of the employer’s business.
• Whether the worker’s managerial skills affect his or her opportunity for profit and loss.
• The relative investments in facilities and equipment by the worker and the employer.
• The worker’s skill and initiative, indicating independent business judgment on part of worker.
• The permanency of the worker’s relationship with the employer.
• The nature and degree of control by the employer.

Consequences of Misclassification

If you don’t comply with the tests above and misclassify your worker as an independent contractor, when they are really an employee, your business could be liable for past-due contributions, back wages, back benefits, taxes, penalty, and interest.

So how can you, the employer, make sure you don’t get hit with hefty penalties for misclassifying your workers?  Here are two red flags that can lead to a finding of misclassification:  (1) when independent contractors are doing things also done by employees, and (2) when companies law off an employee and “rehire” that employee as an independent contractor to save tax and benefit costs.  You should also comply with the above tests, meaning you should make sure that the extent of the relationship with your worker shows a low level of employer control.  If you have an independent contractor, make sure you have a written agreement that lays out the relationship in detail.  Simply having an agreement will not prevent the IRS from assessing back employment taxes, the relationship must still comply with the above tests.  The agreement will be helpful in spelling out the relationship as an independent contractor.

DISCLAIMER:  As always, this is just a general overview of this topic. Everyone’s situation is unique and may require additional and more in-depth information. Any information on this site is not legal advice and should not be construed as such. Additionally, all topics on this blog are relevant to Illinois law only.  Please be aware that the use of this site, including commenting on any blog articles, does not constitute an attorney client relationship. As such, no information sent through this website or posted on the comments section of this blog is not confidential and is not protected by attorney-client privilege. The protection of the attorney-client privilege will not exist until a retainer agreement has been signed.

** If you are in the construction industry, there is another test you should be aware of and comply with in classifying your workers.  It is called the Illinois Employee Classification Act and it applies only to workers performing services for construction contractors on or after January 1, 2008.  The Act can be found here and the factor test relevant to this Act can be found here.  820 ILCS 185/10