Employee or Independent Contractor? UIA Adopts 20-Factor Test

Hiring workers can involve liability for homeowners and businesses alike, even if the workers hired are only part-time or temporary.  An employer should be careful when deciding to classify a worker as an employee versus an independent contractor.  The Internal Revenue Service (IRS) imposes severe penalties upon businesses and homeowners if a worker is misclassified as an independent contractor, rather than an employee.

Effective January 1, 2013, Michigan’s Unemployment Insurance Agency (UIA) adopted the IRS’ 20-factor test used to determine whether a worker is an employee or an independent contractor.  Although this test is complex, requiring analysis on a case-by-case basis, generally, the 20-factors largely center on the extent of “control” the employer has over the worker.  Factors determining an employer’s control over a worker include who sets the worker’s hours, specifies the number of helpers aiding the worker, determines the method and manner in which the work is completed, and furnishes the worker with equipment and/or a place of work.

A worker who is required to comply with instructions about when, where and how he or she is to work is ordinarily classified as an employee.  As an employee, the employer is required to withhold federal income tax, FICA and other social security-type taxes from that worker’s wages.  Furthermore, an employee is issued a W-2 tax reporting statement at the end of the year, versus the Form 1099 received by an independent contractor.

In contrast, if a worker is responsible to the employer on a results-only basis, then the worker is more likely to be considered an independent contractor.  For example, if the worker produces a finished product without supervision, guidance or direction from the employer or if the work done is of the type generally performed by an independent contractor, he or she is more likely to pass the 20-factor test.  An employer is not required to withhold certain taxes from an independent contractor’s wages and issues a 1099 instead of a W-2 at the year’s end.

Careful application of the 20-factor test will guide an employer in the classification of a worker and help to avoid many problems with both the IRS and Department of Labor.  The IRS will charge an employer additional taxes, penalties and interest if an employee is found to be incorrectly classified.  Additionally, through the Department of Labor, a worker could recover back pay and liquidated damages under the Fair Labor Standards Act, as well as attorney fees.  Further, failure to provide workers’ disability insurance (generally referred to as workers’ compensation insurance) could result in potential litigation to the employer if the individual is injured and determined to be an employee, when the employer failed to obtain workers’ compensation coverage.

Gerald C. Davis is a partner in our Livonia office where he concentrates his practice on corporate and business law, leveraged buy-outs, company reorganization and refinancing, analyzing investments for joint ventures, intellectual property, and drafting loan agreements. He can be reached at (734) 261-2400 or gdavis@cmda-law.com.