Laws and Regulations Affecting Independent Contractors
An independent contractor is an individual who does work for another individual or company but is not an employee of the firm that is paying them. These individuals will need to abide by a series of laws and regulations in their business transactions and interactions. The rules they must follow can be both federal and state-level directives.
The contractor is, by definition, independent, and not an employee of the hiring company. A perfect example of an independent contractor is a cleaning service. The service comes into your office to do work, but the cleaning service workers are not employees of your company.
Payment, Benefits, and Taxes
Contractors may be paid by the hour or by the project, depending on the type of work done. The contractor is not an employee of the company and receives no employment benefits. The hiring company does not pay employment taxes on behalf of the independent contractor, including Social Security/Medicare tax and unemployment tax. The hiring company also does not withhold income taxes and employment taxes from the independent contractor.
The IRS requires that workers be properly classified as either employees or independent contractors. It sets up factors for auditors to review when considering the status of a worker: behavioral controls, financial controls, and the nature of the relationship. The IRS assumes that a worker is an employee unless it can be proven that the worker is an independent contractor.
The IRS allows either the worker or the hiring company to apply for a determination on the status of a worker or workers as independent contractor or employee:
- Employers are required to send contractors (those who are paid $600 or more in the course of a year) a 1099-MISC form showing total earnings for the year. The due date for 1099-MISC forms is the end of January, for the preceding year.
- Independent contractors must furnish a valid taxpayer ID number (Social Security Number, Employer ID Number, or other) to the hiring company. If the taxpayer ID is not valid or is incorrect, the hiring company is required to deduct backup withholding from the contractor's payments.
- Because independent contractors are business owners, they must pay self-employment taxes on their earnings from self-employment. Self-employment taxes do not apply if the contractor is the owner of a corporation.
Department of Labor (DOL) Regulations
The relationship between independent workers/business owners and their hiring companies is described as "merely contractual" and not an employment relationship for the purposes of the Fair Labor Standards Act (FLSA) regulations. Thus, independent contractor relationships are not subject to FLSA provisions for minimum wage, overtime, youth employment, and record keeping.
The Department of Labor, like the IRS, reviews workers to determine if they meet the criteria of employees for FLSA provisions. The DOL discusses Supreme Court decisions on independent contractors, which have held that there is no one single rule or test to determine whether someone is an independent contractor or employee for FLSA purposes. The Court has held that it is the total activity or situation that determines the proper status. Among the factors considered significant are:
- The extent to which the services rendered are an integral part of the principal's business
- The permanency of the relationship
- The amount of the alleged contractor's investment in facilities and equipment
- The alleged contractor's opportunities for profit and loss
- The amount of initiative, judgment, or foresight in open-market competition required for the success of the claimed independent contractor.
- The degree of independent business organization and operation.
Other factors deemed immaterial to the question:
- The location where work is performed
- Absence of a formal employment agreement
- Whether the alleged independent contractor is licensed by the state/local government
- Time or mode of pay
Because they are independent business owners, these employment laws are not relevant to independent contractors:
- Americans with Disabilities Act (ADA)
- OSHA (Occupational Safety and Health Act)
- Unemployment Compensation
- Workers Compensation
Most U.S. states have regulations about the status of independent contractors. The states have fines and penalties for not correctly classifying a worker for state employment and wages status. More states are tightening up those requirements to make it more difficult to call a worker an independent contractor. One common test is called an ABC test because it requires that three tests must be met:
- A: The worker must be free from control and direction of the hiring entity.
- B: The worker must be performing work that is outside the scope of the employer's business.
- C: The worker must be "customarily employed" in the same type of work like that being performed for the hiring entity.