Federal Law > Managing Employees > Employees or Independent Contractors

Employees or Independent Contractors


In managing human resources issues, the first critical issue to be determined is whether a person providing service for the business is, in fact, an "employee". If an "employment" relationship exists, a number of independent, legal obligations arise for an employer ranging from minimum wage and overtime requirements under the Fair Labor Standards Act to workers' compensation, unemployment compensation, and federal and state income tax withholding. On the other hand, if the person providing the service is an independent contractor, the legal obligations for the contracting business may be fairly minimal. Relationships with third parties are also dramatically impacted if the person who is providing service on behalf of the company is an employee as opposed to an independent contractor. Employees, particularly management or supervisory employees, have the capacity to legally bind the employer by their actions. On the other hand, independent contractors will not normally create liability for a business by virtue of their actions toward a third party.

Respondeat Superior. In common law, the term respondeat superior, literally "let the master answer", arose in ancient Greek and Roman law. It was used to describe the existence of an agency relationship between an employer and a servant acting within the scope of employment. The doctrine of respondeat superior intervened to prevent employers from walking away from liability for the negligent acts of servants which harmed others. The courts supported the respondeat superior doctrine based upon traditional notions of fairness and equity. The doctrine remains viable to this day and employers should be mindful that the actions of agents, particularly supervisors and managers, may bind the employer to liability in tort under the common law.

Who is an "employee"? The definition of who is an employee under a particular statute will depend upon the provisions of that law. Many statutes, such as the Labor Management Relations Act, Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Americans with Disabilities Act, and the Fair Labor Standards Act to name only a few, define the term "employee". Interpretive case law under these statutes produces differing definitions for employee.

As a general rule, an individual who works for a business is an employee if the business controls the general manner and means of accomplishing a particular task. On the other hand, where a company does not control the methodology and means for accomplishing a task, but is simply interested in the final result, the person providing the service is likely to be an independent contractor.

The "Common Law" test. A handful of tests have been utilized to assist employers and the government in determining who is an employee and who is an independent contractor. Under the common law test, courts have focused upon the following elements:

1. Right to hire and fire.

2. Right to arrange working schedules.

3. Right to supervise.

4. The term of the relationship.

5. The party responsible for providing the place of work and equipment.

6. The skill required for the position in question.

7. Both parties' intentions in forming the relationship.

8. Whether the employer provided any benefits to the employee.

9. The method of compensation.

10. Whether the retained party had the right to determine when work was to be performed.1

In examining the above factors, the courts will determine the extent to which either party has the right to exercise the factor and what the history of the relationship is as it relates to each factor.

The "Economic Realities" test under the FLSA. The "common law" test recited above was attacked as too restrictive for the definition of employment provided under the Fair Labor Standards Act (FLSA). As a consequence, a second test known as the "economic realties" test arose which tended to focus upon the extent to which the workers rendering the service were dependent upon the business which received the benefit of the service. While the courts which enforced this test demanded scrutiny of the entire relationship, the following factors were deemed to be most significant:

1. The worker's opportunity for profit or loss and the amount the worker had invested in the business.

2. The degree of skill required for the work.

3. The length or duration of the relationship.

4. The degree of control exercised by the employer.

5. The extent to which the work was integrated as part of the employer's business.2

The "Hybrid" test under discrimination laws. Yet a third test arose under attempts to interpret discrimination laws such as Title VII and the ADEA. Here, the courts tended to expand the definition of employee in an effort to provide for broader coverage under the anti-discrimination statutes. The "hybrid test" is a fusion of the "economic realties" and the "common law" tests. The most critical element for the hybrid test still was an examination of the "means and manner" of the employee's work. The courts also, however, examine the economic realities of the relationship in existence between the parties. The tendency under the hybrid test was to examine the term "employee" in the context of the federal statute to be interpreted, the mischief (discrimination, etc.) to be corrected, and the ends to be attained.3
Later, when the Fourth Circuit created yet a fourth test applicable primarily in the ERISA context, the United States Supreme Court reversed and returned to the traditional common law test for defining the term "employee".4

"Means and Methods" of performance. Given the myriad of tests applied to define an employee, an employer should generally focus on the common law test to determine whether an individual truly is an employee or may be held to be an independent contractor. In the final analysis, the extent to which the employer exercises control over the "means and methodology" of performance remains the most likely indicator of employment status.

As a practical tip, in order to avoid having an independent contractor labeled as an employee, it is wise for a business to enter into a written agreement with contractors. While the parties attempts to place a label on the relationship is not determinative, it certainly at least signals from the outset the parties belief that an independent contractor relationship exists.

An employer should be mindful of the different approaches which government agencies may take on this issue. Typically, the following approaches may be followed by some government agencies:

The Internal Revenue Service will typically use the "common law" test, consisting of approximately 20 factors. In many states where unemployment compensation is hinged to the Federal Unemployment Tax Act (FUTA), the state unemployment agencies will also use the "common law" test.

Department of Labor, Wage and Hour Division. Because the general approach under the Fair Labor Standards Act has been an extremely broad construction of the employment relationship, the "economic realities" test remains viable under the FLSA.

EEOC. Where the EEOC and the courts are examining issues of discrimination, the "hybrid" test has been used most frequently. In essence, the finder of fact will look at both the employer's right to control and the extent to which the services rendered are an integral part of the employer's business.

Volunteers. On occasion, legal issues are raised in the employment context by individuals who are neither employees nor independent contractors. Many times, those persons are "volunteers" who have sought protection under federal discrimination statutes. Typically, the issue of control is less troublesome where there is no evidence that the person in question has received compensation for work performed.5 In many cases involving volunteers, the courts have held that coverage under discrimination statutes is simply unavailable because the primary purpose of federal discrimination laws is to eliminate discrimination which threatens ones "livelihood". Because volunteers are not compensated, their livelihoods are not threatened.6

Practical suggestions on employment and independent contractor issues.
In addition to ensuring that a written document be drafted to define the status of the individual who is performing independent contractor services, there are some other steps a business can take to avoid having a relationship be declared that of employment. Some suggestions including the following:

1. Lower level managers should be instructed to be careful of how they refer to the relationship between the service provider and the business. Generally, communications between the business entities should, if possible, be at upper levels of the business. Discussions should be directed toward "goals" to be accomplished as opposed to specific instructions on the manner and method of accomplishing the goals. Any instructions to be given to rank and file employees should come from the management of the independent contractor.

2. The business for whom the service is provided should carefully avoid disseminating employee handbooks or other types of materials to the contractor which may infer that an employment relationship exists with the service providers of the independent contractor.

3. Obviously, the service providers of the independent contractor should never be referred to as "employees".

4. Communication with the service providers should be as minimal as possible to again avoid the inference that the business is controlling the "means and methodology" of the service to be provided.

In conclusion, the status of the service provider for any business is a critical issue. Significant tax ramifications and other legal obligations attach to an employment relationship. As a consequence, an employer is well advised to careful structure relationships with independent contractors and volunteers to ensure that such service providers are not determined to be employees of the company.

  1. Deal v. State Farm County Mutual Insurance Company of Texas, 5 F.3d 117, 119 (5th Cir. 1993).

  2. Brock v. Superior Care, Inc., 840 F.2d 1054, 1059 (2nd Cir. 1988).

  3. United States v. Silk, 331 U.S. 704, 67 S.Ct. 1463 (1947); Franco v. Bally, Inc. 987 F.2d 86 (2nd Cir. 1993).

  4. Nationwide Mutual Insurance Company v. Darden, U.S., 112 S.Ct. 1344 (1992).

  5. Haavistola v. Community Fire Company of Rising Sun, Inc., 6 F.3d 211 (4th Cir. 1993).

  6. Smith v. Berks Community Television, 657 F. Supp. 794 (E.D. Pa. 1987): Graves vs. Women's Professional Rodeo Association, Inc., 907 F.2d 71 (8th Cir. 1990).
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