Determining whether members of your workforce should be classified as employees or independent contractors can be difficult. The rules both the IRS and the states have established to determine their status are confusing and if you classify them incorrectly, there can be significant fines. Additionally, once a worker is established as being an employee, they are further designated as being exempt or nonexempt as it applies to the ability to receive overtime pay and other employee benefits.

Lumiere has put together the following guide to help answer many of the questions you might have when classifying your resources.

Independent Contractor (Self-Employed) or Employee?

One of the most critical distinctions a business owner will have to make is whether their resources are independent contractors or employees. Besides the compliance issues, this designation determines who pays the employer taxes which are almost 8% (6.2% for social security is 6.2% and 1.45% for Medicare)

Some key differences that establish a resource as a contractor:

They determine their schedule, time frame for completing, work location.
They do not participate in employee benefits from the employer.
They are ineligible for unemployment in the event of a layoff or termination.

There are some downsides for workers that are classified as contractors

They are responsible for all expenses incurred while completing the job.
They are not protected by anti-discrimination and workplace safety laws
Unless a contract states otherwise, they can be terminated at any time, for any reason.

In determining the categorization of a worker, at question is the degree of control the company holds over the resource and level of independence the resource has across three factors :

Behavioral: Who determines what the worker does and how the worker does his or her job?
Financial: Who controls the economic aspects of the resources job? How is the worker paid, are expenses reimbursed, do they provide their own tools/supplies, etc?
Relationship: Do contracts exist between the worker and company, does the worker have other clients, are there any employee benefits ( pension, insurance, vacation, etc.) for their work?
Companies should weigh all of these factors when determining whether a worker is an employee or independent contractor. While some factors may indicate that the worker is an employee, other factors can indicate they are an independent contractor. There is no “magic” or set a number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Form SS-8

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF).

Misclassification of Employees

There are significant consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes (withholding and social security) for that worker See Internal Revenue Code section 3509 for more information.

Use this chart to help you properly categorize your workers:

Item	Employee	Contractor
Employment Laws	Covered by a number of federal and state employment and labor laws	Not covered by employment and labor laws
Hiring Practice	Applicant receives a job offer. After a person accepts the position, the employer must ask for additional information about the employee such as date of birth, marital status, and citizenship status	Interacts with the person or department that needs the service completed. A contractor typically provides a proposal and enters into a contract with the legal or procurement department of the business.
Tax Documents	Provides name, address, Social Security number, tax filing status, and number of exemptions on a W-4	Provides name, address, Taxpayer Identification Number, and certification about back up through a W-9
Payer’s Tax Reporting Requirements	Reports all money paid to the employee during the tax year on a W-2	Reports payments of $600 or more in a calendar year on a Form 1099
Reporting to Other Agencies	Reports for state and federal Unemployment Insurance	None
Value of Work or Contract	Earns either an hourly rate or a salary	A contract may be for a total amount, an hourly, daily, or weekly amount that ends on a specific date or a total amount to be paid when the job is completed
When Paid	Federal and state laws require that an employee be paid on the normal pay date or earlier if the paycheck is not negotiable on the normal pay date, which can occur on holidays	Accounts Payable pays a contractor after receiving an invoice. The contract dictates when payments are made, such as upon completion of a task or by periodic amounts

Exempt vs. Nonexempt

After you have determined that your workers are employees, you will need to determine if they qualify for overtime wages when they work over 40 hours per week. The differences between nonexempt and exempt employees have been established by the Fair Labor Standards Act (FLSA). The FLSA sets basic minimum wage and overtime pay standards and regulates the employment of minors. The FLSA does not regulate vacation, holiday, severance, sick pay, holidays off, or holiday pay among other things.

Employees that are classified as exempt typically perform job duties considered professional, executive or administrative. The US Department of Labor has a list of the more commonly used exemptions

California Rules

California also follows the three simple requirements to determine whether a worker is an exempt employee under California law:

Minimum Salary. The employee must be paid a salary that is at least twice the state minimum wage for full-time employment regardless if it is a salary or calculated hourly.
Managerial Duties. The employee’s primary duties must consist of administrative, executive, or professional tasks. Their job title is irrelevant.
Independent Judgment. The employee’s job duties must customarily involve the use of discretion and independent judgment while comparing and evaluating possible courses of action and making a decision after considering various possibilities.

If these three requirements are met, the employee will usually be classified as exempt from overtime, minimum wage, and rest break requirements (but not meal break requirements). There are, however, many caveats to this test. Some jobs that are subject to a different test altogether and some employees are only partially exempt; meaning, they are protected by certain labor laws, but not others. The State of California Department of Industrial Relations has provided guidance for exemptions from the overtime laws.

Take Employee Classification Seriously

Misclassification is one of the most common causes of lawsuits against employers, and it is not surprising to learn that regardless of the employer’s size, many have had to pay large amounts of money for misclassifying employees.

Lumiere’s recommends that employees treat worker classification seriously. Employers who maintain a cavalier attitude when addressing employee/contractor and exempt/non-exempt classifications could find themselves burdened with liabilities for fines, unpaid wages, interest, penalties, and most likely - attorney fees.