The gig economy is booming, and with it, the number of businesses relying on freelancers and independent contractors. While this flexible workforce offers many advantages, such as specialized skills and reduced overhead costs, it also presents unique legal complexities. One of the most critical aspects of engaging independent contractors is ensuring proper worker classification from the outset1. Misclassifying an employee as an independent contractor can lead to severe legal and financial consequences, including substantial fines, back taxes, and potential lawsuits. This blog post provides a comprehensive guide to help your business confidently navigate the legal landscape of hiring freelancers and independent contractors.
Please note this blog post should be used for learning and illustrative purposes. It is not a substitute for consultation with an attorney with expertise in this area. If you have questions about a specific legal issue, we always recommend that you consult an attorney to discuss the particulars of your case.
Federal Laws and Regulations
Several federal laws govern the hiring of freelancers and independent contractors. These include:
- Fair Labor Standards Act (FLSA) 3: This law sets standards for minimum wage, overtime pay, and recordkeeping. While it primarily applies to employees, it plays a crucial role in determining worker classification. Misclassifying an employee as an independent contractor can result in violations of the FLSA, leading to penalties and back wages.
- Internal Revenue Code (IRC) 3: The IRC outlines the tax obligations for freelancers, who are generally treated as self-employed individuals. They are responsible for paying self-employment taxes, which include Social Security and Medicare taxes, in addition to income tax on their earnings.
- Occupational Safety and Health Act (OSHA) 3: OSHA sets standards for safe and healthy working conditions. While primarily focused on employees, OSHA regulations may extend to freelancers, particularly when working on-site at a client’s location. For example, if a freelancer is working in a hazardous environment or using specific equipment, they may be entitled to the same safety protections as employees.
IRS Guidelines for Worker Classification
The IRS provides guidelines to help businesses determine whether a worker should be classified as an employee or an independent contractor. These guidelines focus on three main categories: 6
- Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does their job7? Factors to consider include the type and degree of instructions given, the level of training provided, and the presence of evaluation systems. For instance, if a company provides detailed instructions on how to perform tasks, requires specific training, and closely monitors the worker’s performance, it suggests an employer-employee relationship. On the other hand, if the worker has significant autonomy in how they complete their work, it points towards independent contractor status.
- Financial Control: Does the company control the business aspects of the worker’s job7? This includes factors like the worker’s investment in equipment and facilities, whether they incur unreimbursed expenses, their opportunity for profit or loss, and how they are paid (e.g., hourly wages vs. project-based fees). If the worker has a significant financial investment in their work, has the opportunity to realize a profit or incur a loss, and is paid based on the completion of projects, it suggests an independent contractor relationship.
- Relationship of the Parties: How do the parties perceive their relationship6? Factors to consider include the presence of a written contract, whether the worker receives employee benefits (such as health insurance or paid time off), and the permanency of the relationship. If there is a written contract that clearly defines the worker as an independent contractor, the worker is not provided with employee benefits, and the relationship is for a specific project or a defined period, it supports an independent contractor classification.
In addition to these categories, the IRS uses a 20-factor common law test to help determine worker classification8. This test considers various aspects of the working relationship, such as the level of instruction, the degree of financial control, and the type of relationship between the parties. It’s crucial to consider all relevant factors and evidence when making this determination.
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References
1. How to Avoid the Risks of Misclassifying Employees As Independent Contractors, accessed February 4, 2025, https://velocityglobal.com/resources/blog/how-to-avoid-the-risks-of-misclassified-contractors/
2. Dangers of misclassifying workers – Adecco, accessed February 4, 2025, https://www.adecco.com/en-us/employers/resources/article/reduce-the-risk-of-employee-misclassification
3. 3 Federal Freelancer Laws Every Gig Worker Must Know …, accessed February 4, 2025, https://smallbizclub.com/startup/3-federal-freelancer-laws-every-gig-worker-must-know/
4. Employee or Independent Contractor Classification Under the Fair Labor Standards Act, accessed February 4, 2025, https://www.federalregister.gov/documents/2024/01/10/2024-00067/employee-or-independent-contractor-classification-under-the-fair-labor-standards-act
5. Independent contractor defined | Internal Revenue Service, accessed February 4, 2025, https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-defined
6. Independent Contractor or Employee – IRS, accessed February 4, 2025, https://www.irs.gov/pub/irs-pdf/p1779.pdf
7. Lesson 1 – Independent Contractor vs. Employee – Stay Exempt, accessed February 4, 2025, https://www.stayexempt.irs.gov/se/files/downloads/ITG%20L1%20ind%20cont%20vs%20emp.pdf
8. IRS 20 Factor Test – Independent Contractor or Employee?, accessed February 4, 2025, https://gordonkeeter.com/faqs/independent-contractor-or-employee
9. Employee vs. Contractor – A Warning from IRS About Getting it Right – Freeman Law, accessed February 4, 2025, https://freemanlaw.com/employee-vs-contractorworker-classification/
10. IRS 20 questions W2 vs 1099 – GALA Choruses, accessed February 4, 2025, https://galachoruses.org/sites/default/files/IRS-20-questions-W2-vs-1099.pdf