1.3 Definition of an Employee

An employee is defined as a person who provides services for a specific salary or wage under the direction and control of another entity. An independent contractor, on the other hand, performs services for an employer but is not subject to the same level of control as an employee and is not subject to wage, discrimination, tax, or liability laws.

Whether a worker is acting as an employee or an independent contractor is an important question. Both employees and independent contractors provide work in exchange for pay. However, employer obligations to an employee are many and varied. On the other hand, an employer is not vicariously liable for the torts of an independent contractor, and employer obligations are limited to the contract terms. For example, if a worker is an independent contractor, the employer is not subject to wage and hour laws, antidiscrimination laws, federal employee tax withholdings, or vicarious liability law. Given these factors, employers are often eager to classify workers as independent contractors rather than employees. Accordingly, the Internal Revenue Service (IRS) has a keen interest in ensuring employers are not improperly classifying employees as independent contractors when they are really employees, and the tax penalties for improper classification are heavy.1

Is a Worker an Employee or an Independent Contractor?

Unfortunately, there is no clear-cut answer to the question of whether someone is an employee or an independent contractor. Most working relationships have characteristics of both employee and independent contractor classifications. There are three different tests commonly used to determine if a worker is an employee or independent contractor:

1. The common law agency test

2. The economic realities test

3. The IRS 20-factor analysis

Common Law Agency Test

Under the common law agency test, a worker is an employee if the employer maintains the right to control the method of work performed. The level of control retained by the employer is the central question.2 For example, a worker who is classified as an independent contractor but who must conform to strict standards of work hours, grooming, dress, billing processes, reporting procedures, and so on, is really an employee.

Economic Realities Test

The economic realities test seeks to look past technical, common-law concepts of the master/servant relationship to determine whether the “economic reality” of a working relationship renders a worker substantially dependent on a given employer. The deciding point is whether the worker has little freedom to exit the relationship because he or she is economically dependent on the business to which he or she renders service. Courts that have applied the economic reality test have taken the following factors into account:

1. The degree of control exerted by the alleged employer over the worker

2. The worker’s opportunity for profit or loss

3. The worker’s investment in the business

4. The permanence of the working relationship

5. The degree of skill required to perform the work

6. The extent to which the work is an integral part of the alleged employer’s business3

IRS 20-Factor Analysis

Finally, the IRS has adopted the 20-factor analysis as a guide to employers in determining whether workers are indeed independent contractors. Most of these factors relate to control by the employer. The 20-factor analysis considers the following elements:

1. Instructions. Who controls when, where, and how work is to be done?

2. Training. How much training does the employer give?

3. Integration. How closely are the employer’s business processes linked to a worker’s performance?

4. Services rendered personally. How much right of substitution to allow others to do the work does a worker have?

5. Hiring assistants. Does the worker control who is hired as an assistant?

6. Continuing relationship. How long and how often has the worker provided services?

7. Set hours of work. Does the employer set specific and inflexible work hours?

8. Full-time required. Is the worker expected to devote all of his or her resources and time to one employer on a full-time basis?

9. Work done on premises. Does the worker have his or her own place of business?

10. Order or sequence set. Does the employer set the order or sequence in which services must be performed?

11. Reports. Does the employer require submission of regular reports?

12. Payment method. Is the worker paid by the hour or by the job?

13. Expenses. Does the worker cover his or her own overhead expenses?

14. Tools and materials. Does the employer furnish tools and equipment?

15. Investment. What is the level of worker investment in the means of doing the work?

16. Profit or loss. Does the worker bear the risk of loss in the arrangement?

17. Works for more than one person at a time. Does the worker work for more than one employer at a time?

18. Services available to general public. Does the worker offer his or her services to the general public?

19. Right to fire. Is termination dictated by a contract, or does the employer hold a right to fire?

20. Right to quit. May the worker quit without incurring any liability?

For all three tests, the factors listed above are not exhaustive or weighted in any particular priority, and they must be viewed according to the type of work being done and the totality of the working circumstances.

Sometimes a contingent or temporary worker, hired on an ad hoc basis from an employment agency, may become a full-fledged employee for federal law purposes if he or she works for a long time for an employer and performs the same work in the same circumstances as a traditional employee. Likewise, volunteers, who are not employees, may become employees if their service results in the conferral of benefits such as a pension, group life insurance, workers’ compensation, or access to professional certification. The test is whether the benefits constitute “significant remuneration” rather than merely the “inconsequential incidents of an otherwise gratuitous relationship.”4 Partners, corporate officers, directors, and major shareholders are not employees.

Law Applying to a Workplace Scenario

A human resource professional must recognize when an employment law is applicable to the employer and its employees. An HR professional could use the following steps to determine if a law applies to a workplace situation:

1. The first step is determining which federal employment statutes apply to the firm. Some federal laws apply to all employers regardless of size. Such is the case of the Uniformed Services Employment and Reemployment Rights Act (USERRA) and the National Labor Relations Act (NLRA), which we will discuss later in the course. Other statutes have application only if a firm has a specified number of employees. For example, Title VII applies to firms with 15 or more employees, while the Age Discrimination in Employment Act (ADEA) requires 20 employees and the Immigration Reform and Control Act (IRCA) 4 employees.

2. The second step would be to determine if the employer does contract work for a federal or state government. If this is the case, then Affirmative Action rules and other state mandates apply.

3. Third, after assessing which federal laws apply, the HR professional must look to state law. Usually, state law mirrors the federal law, but often the rules in a given state are more strict than federal law, as is the case with most California and New York state employment laws. Many states have same-sex discrimination protections, while the federal government does not. Utah has an antidiscrimination law that applies to firms with 15 or more employees, which expressly revokes any common-law employment protections. Michigan protects employees from weight discrimination.

4. The final step is to understand which common-law rules apply in the state where the business operates.