Can an Independent Contractor Agreement Save You From Misclassification of Employees?
The short answer is: it will not save you. But this is one of those times where you’ll want to hear (or read) the long answer. Why? Because while an Independent Contractor Agreement alone cannot save you, it can help you prove non-employee status or even save you from misclassifying an employee or independent contractor in the first place.
What is employee misclassification and how does it happen?
We’ll be talking about is misclassification of employees as independent contractors. That’s when employers treat (and pay) workers as independent contractors when they are in fact employees. How does that even happen?
It happens because it’s the government who determines whether or not someone is an employee. It’s is not dependent on any contract or label, it’s not even dependent on the parties. Until the IRS or the courts make that determination, the parties themselves can’t be sure if their classification is correct. Why does it matter?
It matters because employees have certain rights under the law. These include things like minimum wage, leaves, contribution on their accounts, insurance etc. These are not for other types of workers.
Unfortunately, many companies have used this to get out of the extra expenses attached to employees. They “label” their workers as independent contractors even if they are no different than employees. So much so that the government has become vigilant in policing this abuse. Today, the IRS can check up on your worker and say “hey, he’s not a freelancer, he’s an employee.” And for many that meant hefty fines and penalties.
Where it gets even trickier is determining if one is an employee vs an independent contractor. There is no simple, black and white independent contractor vs employee test. The IRS definition of an employee and an independent contractor is not cut clean. The two share so many things in common.
How can you tell if one is an independent contractor vs employee?
There is no 100% accurate independent contractor vs employee checklist. There is not one thing that will make a worker an employee, it’s a combination of factors, some of which carry more weight than others. Context also plays a role, such as the line of work and the business of the hirer.
What we have below is a list of those factors and how each of them vary depending on whether the worker is an employee or an independent contractor (IC).
| Factors | Employee | Independent Contractor |
| BEHAVIORAL CONTROL | ||
|---|---|---|
| Instructions | Instructions that affect how or the manner the work is performed | Instructions that pertain to the results. |
| Review | Review of behaviour and the manner of performance | Review of the submissions and recommendations for revisions pertaining to the results only. |
| Training | Employers provide training on method or manner of performance of functions. | IC’s generally invest in their trade, which includes necessary training so it’s unusual for the hirer to provide training for them. |
| FINANCIAL CONTROL | ||
| Exclusivity | Employees generally work for just one employee | Real IC’s should be free to offer their services to several different clients at the same time |
| Opportunity for profit and loss | Employees get a fixed salary regardless of the work accomplished. | IC has opportunity for profit or loss depending on how well he manages his time, to whom he offers his services and business acumen. |
| Reimbursement | Employees don’t generally spend on the job. They are (should be) reimbursed for expenses incurred for work. | IC’s are usually hired to perform the job on a flat fee which includes the costs to be incurred in the performance. |
| Investment in trade | Employers invest in the training of their employees because they are the ones who will benefit the most from it. | The IC invests in its own trade because he stands to profit or lose based on how good he is at it. |
| Method of payment | Employees are paid a fixed salary by hour, day or month. | IC’s are generally paid a flat fee. (Although, it is not uncommon to pay ICs by the hour as well.) |
| RELATIONSHIP | ||
| Written Contract | Employees have employee contracts or employee offer letters that say they are employees. | In their contracts, IC’s are usually labelled as ICs, subcontractors, Freelancers, Consultants etc. More importantly, the terms will show that the terms of engagement that reflect IC status as discussed above. |
| Service performed | Employees perform the key activities or the those that are “integral to the core” of the business of the company. | Services other than those integral to the core of the business of the company |
| Permanence | If a worker is hired on a permanent basis, it will usually point to an employee status. The reason being: if his work is needed permanently, then it could be argued that that work is integral to the core business of the company. | ICs are usually contracted for a project or for distinct period of time. However, it is not unheard of to hire the same IC for very long periods of time. |
| Benefits | Employees get employee benefits like overtime, annual leaves, bonuses etc. | ICs do not get employee benefits because they get paid for the work they are hired to perform as a matter of a b2b transaction, essentially. |
Then why have an Independent Contractor Agreement?
While having an Independent Contractor Agreement won’t make your IC an IC, it will help you prove that he or she is. To determine whether a worker is an employee or not, the IRS or the courts will look at the terms and conditions of his engagement. If you have and Independent Contractor Agreement, all those terms will be in that one contract. So, to show that a worker is an independent contractor, you’ll only need to refer the contract. Seems simple right? But imagine the alternative: how would you prove or disprove that you have control over the manner of performance if there was no contract? How would you prove what work the person is doing for your company? It would be a mixture of emails, texts, anecdotes, etc. But not one of which would expressly say what you can or cannot control in terms of the work being done.
Also, going through the process of creating an Independent Contactor can possibly pre-empt misclassification. When you sit down and go through the terms of the Independent Contractor Agreement, you will be able to see the big picture and tell for yourself whether you have or need control over the worker (financial or behavioural) or if you are treating them like an employee. At that point, you can either change the terms or hire the him as an employee instead. If you use our Independent Contractor Agreement Generator, we’ll even give you tips and additional info while you fill out the contract.
How do you make an Independent Contractor Agreement that helps you avoid misclassification?
The best thing to do is to make sure you are tailoring the terms and conditions of your engagement with the IC in such a way that minimizes the possibility of him or her being classified as an employee later on. Follow the pointers below on avoiding the appearance of having behavioural or financial control over the IC, or an employer employee relationship.
Behavioral Control
Employers have or need to have behavioural control over employees because it is them who stand to profit or lose when they perform or behave well or badly. On the other hand, the employer loses or gains nothing from the good performance or behaviour of the IC. This is because what he is paying for when it comes to the IC is results.
- Make sure the instructions you give or you are allowed to give under the contract only pertain to the final product, output, or the results. This means not prescribing things that pertain to the method or manner of performance. That includes not specifying so many things that it effectively confines the IC into as specific manner of performance. Examples of instructions that show employee status include requiring the IC to work at a specific place or at specific times or use particular tools or techniques when there are other ones available that can produce the same effect.
- Make sure that whatever review, evaluation or revisions allowed under the contract pertain only to the desired result or output. Evaluation based on attendance, workplace etiquette, efficiency end skill are likely to indicate employee status. This includes performance reviews.
- Requiring or providing training should be avoided unless it is essential to the final product or output desired. Training, if any, should be limited to orientation and introduction to internal processes. It should veer away from techniques or methods involved in performing the job.
Financial Control
Avoid including conditions that give you financial control. The Independent contractor’s financial independence comes from the opportunity for profit or loss based on his business strategy. He is stands to earn more if he manages his time better, invests in his trade with tools or training, and choses his clients well. The more the contract impairs his ability to do these things the more financial control the hirer will have over him. The more financial control the hirer has, the more likely it is that he worker is an employee or will be classified as one.
- Avoid stipulating exclusivity. If under the contract, the IC is not allowed to work for other clients, he becomes fully dependent on your company for income. He loses opportunities to profit or lose based on his business acumen because it does not matter how he manages his business, his income will be the same because it will come from you.
- As much as possible, costs that the IC will incur, including those for tools and training, should be on his account. This is his investment in his trade from which the possibility of him making profit or losing money comes. Clauses and provisions allowing or committing reimbursements for costs or for providing equipment should be avoided.
- Stipulating flat fees that covers the whole job is ideal. As much as possible payments should be dependent on the completion of the job or the ability to carry it out and not on mere attendance. If the job is a continuing one or one that will take a long time, it’s ok to pay by milestones or even by the hour, day, week or month. However, doing so, especially when paired with a permanent position, is more common for employees. Avoid stipulating overtime, holiday pay and the like as these pertain to employees.
Employer-Employee Relationship
Keep your relationship with the IC transactional, as much as possible. Building goodwill is ok, but make sure that there is a clear delineation between to how you treat the IC and your employees.
- Avoid extending other benefits to the IC, especially those that pertain to your employees. This includes paid leaves, performance bonuses, company perks like gym membership etc. As much as possible, think of paying the IC as a simple business to business transaction. Of course incentives to create goodwill is fine but make sure that there is a distinction as to what the IC gets and why, and what employees get.
- In terms of services to be
performed, look at the work you are hiring the IC for in the context of your
business. Is it “integral to the core” of your business? What
does that mean? It’s very vague but think of it as any work that is necessary
for the company to carry out its main purpose. If the IC’s services are
integral to the core of your business, then it’s more likely that he is an
employee or will be classified as one. If this is the case, it may be better to
consider hiring him or her as an employee.
- A good way to check if a person is doing work that is integral to core business would be to ask, if everyone who doing that person’s job was absent, would that office need to close or would it still be able to deliver services to the clients it will see that day? If the office will have to close for the day, then that person’s job is very likely to be integral to the core.
- Term of service should be definite. The end of the term should either be a specific date or an event that is sure to happen, like completion of the project. Because if your business needs the services of the IC permanently, then it can be argued that he is performing services that are integral to the core of your business and hence should be an employee.
Is there anything else?
Yes. You don’t have to follow every single one of the suggestions above. There are instances where engagement of an bonafide independent contractor will require one or a few things we mentioned you should avoid. But that does not mean they will automatically be employees. For example, sometime you will have to require the IC to report to your office to get the job done like in case of a repairman, right? The point is to require only the things that are necessary for the result and to pass up on the things that are not relevant.
Lastly, when in doubt, be guided by these three questions:
- Am I controlling the worker instead of just the result?
- Am I treating the worker as I would an employee?
- Do I have an employee that does exactly what this worker will be doing?
A yes for either question means that you’re increasing the possibility that the worker will be considered an employee.