Independent Contractor vs. Employee: In Tax vs. Labor Law

Summary

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Podcast Summary: ACTEC Trust & Estate Talk

Episode Title: Independent Contractor vs. Employee: In Tax vs. Labor Law
Date: November 5, 2024
Host: Travis Hayes (ACTEC Fellow, Naples, Florida)
Guest Expert: Lee Stoutberg (ACTEC Fellow, Cincinnati, Ohio)

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Overview

This episode unpacks the crucial distinctions between independent contractors and employees—clarifying the different standards under tax law (IRS), labor law (FLSA), and ERISA. Host Travis Hayes and guest expert Lee Stoutberg delve into why correct worker classification matters, explore the new Department of Labor Fair Labor Standards Act (FLSA) six-factor test effective as of March 2024, and examine how this compares to IRS and ERISA tests. The episode addresses both the practical and legal ramifications of misclassification, with actionable insights for employers, advisors, and workers.

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Key Discussion Points and Insights

1. Importance of Proper Worker Classification

• Impact on Workforce: As of March 2024, 36% of the U.S. workforce are independent contractors. (00:38)
• Risks of Misclassification:
  • Legal and financial consequences for employers if workers are wrongly classified as independent contractors instead of employees. (01:46)
  • Examples include liability for payroll taxes, benefits like 401k and health insurance, compliance with wage laws, and potential lawsuits. (02:11, 02:45)

Quote

"Misclassifying workers can expose employers to class actions and lawsuits ... For example, in 2015, FedEx settled a class action lawsuit for $228 million after the 9th Circuit found ... FedEx had mistakenly classified 2,300 truck drivers as independent contractors."
— Lee Stoutberg, (02:11)

2. Consequences of Misclassification

• FLSA Compliance: Employers must pay minimum wage and overtime unless an exemption applies, currently at $7.25/hour and time-and-a-half for overtime. (01:53–02:07)
• IRS Penalties: Failure to deposit proper payroll taxes leads to penalties (2–10% of unpaid deposit plus interest). (02:36)
• Back Benefits: Employers may owe back benefits like 401k, health insurance, paid time off. (02:45)
• I-9 Documentation: Failing to complete I-9 forms for misclassified workers may lead to civil fines. (02:54–03:07)
• Tax Deductions: Workers may be denied trade or business deductions if misclassified. (03:13)

3. Historical Framework

• Supreme Court Guidance: The 1947 case U.S. v. Silk established the "economic reality" test, evaluating whether workers are economically dependent on the employer based on the nature of work, opportunity for profit/loss, and degree of independence. (03:29–04:11)

4. New FLSA Six-Factor Test (March 2024)

Stoutberg walks through the updated DOL six-factor test that is currently central to FLSA employee/contractor classification. (04:14–05:53)

Breakdown of the Six Factors:

1. Opportunity for Profit or Loss Based on Managerial Skill

   • Looks at the worker’s autonomy—ability to negotiate pay, accept/decline jobs, and choose work order.
   • (04:14–04:30)

2. Investments by Worker and Employer

   • Minor investments by a worker suggest employee status.
   • (04:30–04:35)

3. Degree of Permanence in Work Relationship

   • Continuous/exclusive relationships signal employee status.
   • (04:35–04:41)

4. Nature and Degree of Control

   • Ability to set own schedule, work unsupervised, and work for others points toward contractor status.
   • (04:41–04:59)

5. Integral Part of Employer’s Business

   • If the worker’s tasks are core to the employer’s business, this indicates employee status.
   • Example: Tomato pickers at a farm. (05:03–05:17)

6. Skill and Initiative

   • Workers using specialized, marketable skills for multiple clients may indicate contractor status.
   • Example: A welder working for many clients. (05:33–05:53)

Quote

"A welder who markets specialized skills for multiple customers has a characteristic of an independent contractor."
— Lee Stoutberg, (05:53)

5. IRS and ERISA: Separate But Overlapping Standards

• IRS Test:

  • Traditional "20-factor" control test, reduced to three categories: behavioral control, financial control, and relationship of the parties. (06:01–07:15)

• ERISA Test:

  • Supreme Court's Nationwide v. Darden uses a common law agency test, focusing on control and other relationship factors. (07:15–07:40)

Commonalities & Divergences

• Overlap: All three tests consider opportunity for profit/loss, investment, permanency, integration into the business, and degree of control. (07:45–08:10)
• Key Differences:
  • The FLSA test is broader, aiming for economic dependence.
  • IRS and ERISA rely on common law concepts, with more emphasis on control.
  • FLSA's "suffer or permit to work" standard can encompass more workers as employees than traditional agency tests. (08:14–08:40)

Quote

"The answer ... may have more to do with how the factors are weighed and interpreted than with the factors themselves."
— Lee Stoutberg, (08:19)

6. Practical Guidance for Employers

• Proactive Approach:
  • Employers analyzing FLSA status may choose to treat more workers as employees across the board, even for tax/benefits purposes, to avoid risks of reclassification. (09:02–09:11)

Quote

"Employers proactively looking to properly classify workers for FLSA purposes may voluntarily choose to treat more workers as employees for all purposes."
— Lee Stoutberg, (09:05)

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Memorable Moments & Notable Quotes

• FedEx Lawsuit Example: (02:11)
• Tomato Farm Analogy: Shows how integral work is to employer’s business (05:08–05:17)
• Distinction on Economic Dependence vs. Control: (08:40–08:55)

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Timestamps for Important Segments

• Introduction & Context: 00:05–01:12
• Why Misclassification Matters: 01:46–03:16
• Historical Legal Context: 03:29–04:11
• Detailed Six-Factor FLSA Test: 04:14–05:53
• IRS & ERISA Approaches: 06:01–07:40
• Overlap and Divergence of Tests: 07:45–08:55
• Practical Employer Considerations: 09:02–09:11

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Conclusion

This episode of ACTEC Trust & Estate Talk, guided by expert Lee Stoutberg, serves as a comprehensive primer on the shifting landscape of worker classification. Listeners receive up-to-date, nuanced guidance vital for legal compliance and risk management when hiring and classifying workers.

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Transcript

[A]

Independent contractor versus Employee and tax versus labor law that's the subject of today's ACTEC Trust and Estate Talk.

[B]

Welcome to ACTEC Trust and Estate Talk from the American College of Trust and Estate Counsel, a professional society of peer elected trust and estate lawyers in the United States and around the globe. This series offers professionals best practice advice, insights and commentary on subjects that affect our profession and clients. And now, our ACTEC Fellow Host with today's topic.

[A]

This is Travis Hayes, ACTECH fellow from Naples, Florida. 36% of the United States workforce are independent contractors as of March 2024. What happens when a worker classified as an independent contractor is reclassified as an employee? What risks and laws do employees and hiring managers need to keep in mind? ACTEC Fellow Lee Stoutberg of Cincinnati, Ohio joins us today to discuss the new Fair Labor Standards act six factor test versus the IRS and ERISA standards for classifying independent contractors and employees. Welcome, Leigh.

[C]

Thank you, Travis.

[D]

I appreciate the opportunity to be on this podcast.

[C]

The Fair Labor Standards act, or flsa, is a federal law that establishes minimum wage, overtime pay and child Labor Standards. On March 11, 2024, the Department of Labor published a final rule revising the DOL's guidance on what constitutes an independent contractor versus an employee. In the next few minutes, I will discuss the intersection of the FLSA's six.

[D]

Factor test, state and federal characterization and.

[C]

Touch on ERISA characterizations of employees versus independent contractors.

[D]

Before doing so, let's consider some of the things that can go wrong if.

[C]

A worker is mischaracterized as an independent contractor.

[D]

FLSA Minimum Wage and Overtime Unless an.

[C]

Exemption applies, FLSA requires that workers classified as employees be paid minimum wage currently.

[D]

$7.25 and overtime at not less than.

[C]

Time and 1/2 for all hours worked over 40 hours.

[D]

Also, misclassifying workers can expose employers to class acts and lawsuits. For example, in 2015, FedEx settled a class action lawsuit for 228 million after.

[C]

The 9th Circuit found in the case.

[D]

Alexander v. FedEx that FedEx had mistakenly.

[C]

Classified 2,300 truck drivers as independent contractors. And also there's employer liability for payroll taxes, Social Security and Medicare taxes.

[D]

The IRS imposes a failure to deposit.

[C]

Penalty ranging from 2 to 10% of of the unpaid deposit with interest.

[D]

There are back payments to workers for.

[C]

Missed benefits like 401k, health care, equity compensation, paid time off and family and medical leave. Failure to keep i9s employer must complete.

[D]

And retain i9 documentation with respect to.

[C]

All workers who are classified as employees.

[D]

For as long as the employee continues to work for the employer and for some time thereafter. A failure to complete and retain I9.

[C]

Documentation for misclassified employees may lead to civil fines for the employer and at the worker lever there is a denial of trade or business deductions.

[D]

So it is important to get the.

[C]

Right classification of a worker as an.

[D]

Employee versus an independent contractor. Getting this right. Now let's step back and think about history a bit. In 1947, the Supreme Court looked at.

[C]

The case U.S. v. Silc.

[D]

In this case, the court employed an economic reality test to hold that coal uploaders were employees. In determining whether these particular workers were independent contractors or employees within the meaning.

[C]

Of the Social Security act, the court applied the same rules as the National Labor Relations act and Labor Board B. Hearst publications.

[D]

In SILC, the U.S. supreme Court noted.

[C]

That coal uploaders had no opportunity to gain or lose except from the work of their hands and silk simple picks.

[D]

And shovels that the workers provided. This economic reality test is basically the.

[C]

Same as what has been used to effectuate the flsa.

[D]

Now let's get to this new FLSA six factor test.

[C]

The first factor Factor Number one Opportunity.

[D]

For profit or loss based on managerial skill. Basically, this factor looks at whether the.

[C]

Worker can do things like negotiate, pay.

[D]

Accept, or decline jobs.

[C]

Choose the order in which the work is performed and how others Factor number.

[D]

Two Investments by the worker and potential employer. If the investment is minor, this is.

[C]

An indication of an employee. Factor number three Degree of permanence and work relationship.

[D]

Is the work relationship continuous or exclusive? This would indicate an employee. Factor number four Nature and degree of control. Can the worker set their own schedule?

[C]

Is the work supervised by others?

[D]

Is the work limited in the work he or she can do for others? Factor number five Extent to which the.

[C]

Work is performed is an integral part of the potential employer's business.

[D]

Is the work critical, necessary, or central.

[C]

To the potential employer's principal business?

[D]

For example, a large farm grows tomatoes that it sells to distributors. The farm pays workers to pick the tomatoes during the harvest season. Because a necessary part of the tomato.

[C]

Farm is picking the tomatoes, the tomato pickers are integral to the company's business. These facts indicate status under the integral factor. Factor number six Skill and initiative. Does the worker use specialized skills and do these skills contribute to a business like initiative?

[D]

This factor indicates employee status.

[C]

If the worker does not use specialized skills in performing the work or where the worker is dependent on training from the potential employer to perform the work.

[D]

It is not only the technical skills.

[C]

But also the use of the skills in connection with a business like initiative. For example, a welder who markets specialized skills for multiple customers has a characteristic.

[D]

Of an independent contractor. Okay, so now that we have this.

[C]

New six factor FLSA test down, let's think about the IRS rules on characterizing.

[D]

Employers versus Independent contractors. The FLSA and IRS can arrive at.

[C]

Different conclusions as to what is an employee or an independent contractor.

[D]

The Department of Labor's FAQs specifically state.

[C]

That the IRS applies its own test.

[D]

Based on a common law test.

[C]

The Economic Reality six factor test as used by the FLSA is broader because as a matter of economic reality, the worker is economically dependent on an employer for work.

[D]

In rev.

[C]

Rule 87:41, the IRS put forward 20 factors that it identified as indicating whether sufficient control is established to represent an employer employee relationship. These factors included level of instruction, amount of training, degree of business integration, extent of assistance, continuity of relationships, flexibility of.

[D]

Schedules, demands for full time week, need for on site services, sequence of work, requirements for reports, and so on.

[C]

The IRS has acknowledged that these are not the only factors that are important. The IRS divides these types of factors into three categories of evidence 1 behavioral control, 2 financial control and 3 relationships of the parties.

[D]

While these evidence categories, some of the old evidence factors have been prioritized, with.

[C]

Certain factors being of lesser importance.

[D]

ERISA has its own common law employee test. In Nationwide v. Darden, the Supreme Court.

[C]

Adopted a common law test using general agency principles for determining who qualifies as.

[D]

An employee under ERISA, considering 13 factors. Hiring parties right to control the manner.

[C]

And by means by which work is done Skill the worker are two of these 13 factors. Does this sound familiar? As with similar tests, all of the incidents of the relationship must be assessed.

[D]

And weighed with no factor being decisive. The commonalities among The FLSA new six.

[C]

Factor test, the IRS 20 factor test and the ERISA Common Law Test Workers opportunity for and realization of profits and losses workers investment in facilities and equipment.

[D]

A continuing permanent relationship between the worker.

[C]

And the employer integration of the worker services to the activities of the company, nature and degree of control.

[D]

These areas of overlap can be especially important to consider when analyzing whether to.

[C]

Classify a worker as an employee or independent contractor.

[D]

Where do these tests diverge?

[C]

The answer to this question may have more to do with how the factors.

[D]

Are weighed and interpreted than with the factors themselves. The FLSA definition of employment, suffer or.

[C]

Permit to work is recognized as potentially encompassing a broader group of workers than those who might qualify as employees under traditional agency or common law tests. An interpretation that favors finding employee status may be more appropriate when applying the FLSA test.

[D]

Per the Department of Labor, economic dependence.

[C]

Rather than control is the ultimate inquiry for purposes of the FLSA is a worker as a matter of economic reality and business for themselves. Although classification for FLSA tax and benefits purposes should be independent considerations, as a.

[D]

Practical matter, reclassification under the FLSA may.

[C]

Prompt reclassification analysis other purposes as well.

[D]

Employers proactively looking to properly classify workers.

[C]

For FLSA purposes may voluntarily choose to.

[D]

Treat more workers as employees for all purposes.

[A]

Travis thank you, Lee, for discussing with us the distinctions in labor and tax law when classifying independent contractors and employees.

[B]

Thank you for listening to this episode of ACTEC Trust and Estate Talk, the podcast series about wealth planning matters from the American College of Trust and Estate Council. To find an ACTEC lawyer near you, visit actec.org Please subscribe to this series and leave us a rating or a review.