Independent Contractor Laws and Regulations
Independent Contractor Laws and Regulations: What makes an employee different from an independent contractor (IC)? On both the state and federal levels, attempting to make this decision has been a never-ending struggle. With the growth of the gig economy, this problem has only become worse. For example, California is at the center of a legal fight over how Uber and Lyft drivers should be categorized, and the US Department of Labor (DOL) is rethinking its worker categorization system.
Why Does It Matter Whether You’re an Independent Contractor or an Employee?
The Department of Labor (DOL) and the Internal Revenue Service (IRS) see the IC vs. employee situation as a “misclassification” issue, implying that workers are being misclassified as contractors. State and federal legislation, as well as federal courts, presume that the worker is an employee; if the employer mistakenly defines the person as an independent contractor, the worker loses the benefits that employees are entitled to.
Businesses often designate employees as independent contractors (ICs) since they are less expensive (no benefits to pay) and the connection may be terminated more quickly.
- Misclassification of Workers as Independent Contractors Has Serious Consequences
- Minimum wages, overtime pay, retirement benefits, and other labor law safeguards are not available to them.
- Unemployment insurance and workers’ compensation are generally not available to them.
- Anti-discrimination, OSHA, and other employment regulations do not apply to them.
- They are responsible for paying their own self-employment tax (Medicare/Social Security).
On the other hand, certain employees, such as ride-sharing drivers, benefit from the flexibility of being self-employed, which allows them to choose where and when they work, as well as deduct costs to lower their taxes.
ICs are treated by the IRS as distinct companies that have a contractual connection with a recruiting firm. When determining worker categorization for tax reasons, IRS regulations use a set of common law criteria (behavioral, financial, and kind of connection).
Meanwhile, the Department of Labor (DOL) establishes guidelines for establishing worker categorization for the purposes of benefits and work regulations. The IRS’s common-law standard is not utilized in these regulations. Workers hired by a “virtual marketplace” business (including transportation and delivery services) are ICs, not employees, according to a DOL opinion letter published in 2019.
The Department of Labor suggested an “economic reality” test to assess whether a person is an employee or an independent contractor in September 2020. There are two main components to the test:
- The type and extent to which the worker has influence over his or her job
- Opportunity for profit or loss for the worker depending on initiative and/or investment
It also considers a number of additional variables, such as:
- The level of expertise needed for the job
- The long-term viability of the employer-employee working relationship
- Whether the job is part of a larger manufacturing unit
Independent Contractors’ State Laws and Regulations
Workers may be classified as employees under state law even if they are not classified as such under federal law, and some states have stricter criteria for ICs.
The IRS common law test (or a variant) is used in several states, including Florida, Iowa, and Michigan.
California, New Jersey, and Virginia, for example, employ a more restricted worker categorization standard known as the ABC test.
Unless all three requirements are met, the ABC test deems a worker to be an employee:
A: The employee is free of the hiring entity’s control and direction.
B: The employee does work that isn’t part of the company’s normal operations.
C: The worker is usually involved in a separate trade, profession, or company that is similar to the job done by the employing organization.
Drivers of Ride-Hailing Services Are Classified
States have been grappling with problems of driver categorization since ride-sharing became increasingly popular in the late 2000s, and the rise in unemployment has exacerbated the debate. Uber, Lyft, and Doordash, for example, have claimed that their drivers are self-employed independent contractors.
In recent years, the categorization problem has been the subject of many rules and litigation.
The National Labor Relations Board (NLRB) decided in April 2019 that Uber drivers are independent contractors (ICs) who are not covered by the National Labor Relations Act.
Uber drivers and the New York Taxi Workers Alliance sued the state and city of New York for failing to pay unemployment compensation in July 2020. For those benefits, the New York Department of Labor had already concluded that the drivers were Uber workers.
Meanwhile, California has been fighting Uber, Lyft, and other app-based ridesharing businesses over the status of its drivers in court. California Assembly Bill (AB) 5 makes the ABC exam an official component of state law on January 1, 2020. Because the ride-hailing firms failed to follow the legislation (AB5), a California Superior Court judge decided in August 2020 that Uber and Lyft’s “ride-hailing drivers” could not be classed as ICs.
Laws Regarding Independent Contractors Can Vary
To make matters even more complicated, different federal agencies and states have different IC standards for certain circumstances. For example, a person may be categorized as an IC under labor law (the Fair Labor Standards Act) but may be classified differently under tax and state law.
Furthermore, each scenario is assessed on its own merits. The United States Supreme Court has said that the “whole action or circumstance” is what matters, and state and appellate courts may decide differently in particular cases.