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U.S. Department of Labor Futurework
  Trends and Challenges for Work in the 21st Century
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Flexible Staffing Arrangements

A Report on Temporary Help, On-Call, Direct-Hire Temporary, Leased, Contract Company, and Independent Contractor Employment in the United States

Susan N. Houseman
August 1999

9.1 Who Is an Employee? Determining Independent Contractor Status

Independent contractors, by definition, are self-employed and because they are not employees, independent contractors are not covered by employment, labor, and related tax laws. Employers may be tempted to reclassify employees as independent contractors in order to avoid taxes, benefits, and other liability. Whether or not a worker is covered by a particular employment, labor, or tax law hinges on the definition of an employee. Yet, statutes usually fail to clearly define the term "employee", and no single standard to distinguish between employee and independent contractor has emerged.

For example, the IRS uses the so-called “20-factor test,” in which it assesses the degree of control the company exercises over the way the work is performed by the independent contractor. If the company exercises too much control, the worker is deemed to be an employee. Employers do not have to pay FICA (social security and Medicare) and FUTA (federal unemployment insurance) taxes on independent contractors, nor do they have to withhold federal income taxes for these individuals. The IRS, which estimates that it loses billions in tax revenue each year due to misclassification of employees as independent contractors, has cracked down on the problem in recent years.

The IRS 20-factor, right-to-control test is used to assess an employers’ tax liability. A similar test is used in most states to determine status under workers’ compensation laws. The so- called “economic realities test” or a hybrid of the right-to-control and economic realities test often is used by courts to determine independent contractor status in other circumstances. In essence, the economic realities test makes it harder to classify a worker as an independent contractor, because, in addition to considering the degree of control the employer exercises, it takes into account the degree to which the workers are economically dependent on the business. The economic realities test is used to determine employee status under the Family and Medical Leave Act (entitling workers to unpaid leave under certain circumstances), the Fair Labor Standards Act (establishing a minimum wage), and the Worker Adjustment and Retraining Act (providing for advance notice in event of plant closings and mass layoffs). Additionally, it is often applied by courts in determining independent contractor status in civil rights cases under Title VII of the Civil Rights Act, the Age Discrimination in Employment Act, and the Americans with Disabilities Act. States use a variety of other tests to determine independent contractor status for unemployment insurance purposes.19

The plethora of tests defining independent contractor status applied across federal and state laws makes it possible for a worker to be classified as an independent contractor under one law, but as an employee under another. The Commission on the Future of Worker-Management Relations (1996) recommended simplifying and standardizing the definition of an employee in employment, labor, and tax law to reduce confusion and stem the abuse of misclassification of workers as independent contractors. The Commission recommended that a standardized test be based on the more restrictive concept of economic realities.

(19) Joerg (1996, chapters 3 and 7) contains a detailed discussion of the IRS 20-factor test, the economic realities test, and various other tests.

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