Who is an Employee?
There are many laws that affect the relationship between employers and workers. For business owners, the first step comes in understanding who is an employee and who isn't.
Here, we provide an overview of the laws that help define the differences between employees, common law employees, statutory employees and independent contractors.
Common Law Employees
Under common law rules, courts balance a number of factors to determine whether an employer- employee relationship exists. The employer‘s right to control the manner and means of performing the work is the most important factor distinguishing an employer-employee relationship. It does not matter that the employer gives the employee substantial discretion and freedom to act, so long as the employer has the legal right to control both the method and result of the service.
Here are some of the other factors examined by the courts in determining whether an employment relationship exists.
Mode of Payment
Workers who are paid on a regular basis, e.g., hourly or biweekly, are more likely to be considered employees than are persons who are paid a fixed amount for a specific service, regardless of the amount of time taken to complete the task. Withholding for taxes and providing fringe benefits such as medical insurance are considered typical of an employer-employee relationship.
Materials and Tools
A person who furnishes his or her own materials and tools and equipment and has a significant investment in the tools and equipment used in connection with providing the service is less likely to be considered an employee than is a person who uses tools and materials furnished by the hiring entity.
Control of the Premises
An employer-employee relationship is more likely to be found where the hiring entity owns or controls the premises where the work is performed. Premises controlled by the service provider or by a third person are considered more characteristic of an independent contractor relationship.
Right of Discharge
The ability of the hiring entity to terminate or discharge the worker and/ or the ability of the worker to leave before the task is completed without becoming liable for nonperformance under the contract or agreement also are factors examined in determining whether an employment relationship exists.
There's More to Consider
It is important to note, however, that none of the above factors, standing alone, determines whether an employment relationship exists. The most important factor is the hiring entity’s right to control the manner and means of completing the work. Doubtful situations generally are resolved by examining the facts of the specific case in light of all relevant factors.
If an employment relationship exists, the legal requirements placed on employers will apply regardless of what the parties call the worker, regardless of how payments are measured or made, and regardless of whether the person works part time or full time, unless a statutory exception applies to the situation.
If a worker is a common law employee, the business by law must obtain workers‘ compensation coverage, withhold FICA (Social Security and Medicare) and income taxes, pay the employer’s share of the FICA tax and pay federal and state unemployment taxes. Fair labor standards laws, occupational safety and health requirements and a variety of other federal and state laws also may apply.
Even if a worker is not an employee under common law rules, he or she may be considered an employee for certain statutory purposes, such as FICA (Social Security and Medicare) tax, federal and state unemployment insurance taxes, workers’ compensation, Fair Labor Standards Act compliance, occupational safety and health requirements, and other statutory programs. Likewise, a federal or state statute may exempt certain employers or employees from its application.
Because both federal and state statutes define employees covered by their respective laws, both sources must be consulted before concluding a legal requirement is not applicable to a specific situation. Special rules apply to certain occupations, such as salespersons, and to special situations such as family owned businesses that employ family members.
The definition of “employee” often involves a legal determination. For this reason, particularly in unclear cases, it is important to consult an attorney before concluding an individual is not an employee.
If a worker is a statutory employee, the business does not withhold federal or state income tax. Employers should consult an attorney or other competent tax adviser with respect to withholding Social Security and Medicare taxes and paying unemployment tax. Fair labor standards laws will probably apply.
An independent contractor is himself or herself a sole proprietor of a business, and not an employee of the firm who contracts with them.
The question of whether a worker is an independent contractor or an employee may be determined by common law rules or by statute. A person may be an employee for certain purposes but not for others. If questions arise, employers are strongly urged to seek professional advice.
Business owners who use “independent contractors” may think they do not have employees and employment laws do not apply to them. But an individual’s status as an independent contractor is not determined by agreement or by what he or she is called. The status is determined by what he or she does.
Many companies engage independent contractors, rather than employees, to fill temporary and sometimes permanent staffing needs. Such an arrangement is often beneficial for both companies and workers. Companies avoid paying certain taxes applicable to employees and are able to pay their workers by the project, without overtime pay. Workers gain flexibility that might not be available as an employee. In determining whether a worker is an employee or an independent contractor, companies often use the IRS “right to control” standard.
Different laws apply varying tests to determine whether a worker is an employee or an independent contractor. While the IRS applies “right to control” test, many other statutes apply a more employee-favorable standard such as “economic dependence” or “economic realities” test. In other words, even if the worker is not controlled by the company a worker may still be an employee if they are in fact economically dependent on the work just like an employee.
The U.S. Department of Labor considers six factors in determining the nature of a working relationship:
- Is the work an integral part of the employer’s business? If yes, employee status is indicated
- Does the worker’s managerial skill affect the worker’s opportunity for profit or loss? If no, employee status is indicated
- How does the worker’s relative investment in his or her business compare to the employer’s investment? If the worker’s investment is minimal compared to the employer’s investment employee status is indicated)
- Does the work performed require special skill and initiative? If no, employee status is indicated
- Is the relationship between the worker and the employer permanent or indefinite? If yes, employee status is indicated
- What is the nature and degree of the employer’s control over the worker? If employer has control, employee status is indicated
The DOL says misclassification of workers as independent contractors has been increasing. To combat the problem, the DOL has entered into a cooperative agreement with the IRS and the state of Minnesota. The agreement allows both the federal agencies to share information and more easily discover misclassification. Penalties for misclassification are harsher.
Consultants at our Small Business Assistance Office can help you understand more about all the factors you'll need to consider before you hire employees. And our network of Small Business Development Centers has experts located in nine main regional offices and several satellite centers statewide.
Our Guide to Starting a Business in Minnesota covers this and An Employer's Guide to Employment Law Issues in Minnesota provide a deeper look at this and other issues that commonly arise in the workplace.