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DOL and IRS Independent Contractor Test

On Behalf of | Mar 11, 2024 | Business And Corporate Law


Whether a worker is an employee or an independent contractor is an important question to answer. Correctly answering this question is crucial for both businesses and workers. If a business or worker fails to correctly classify the working relationship, there can be steep implications at the local, state, and federal levels. To help make sure you identify your professional relationships correctly, speak to an experienced attorney like the top-rated employment legal issues attorneys at Batson Nolan PLC.

Today, we want to briefly review how you identify independent contractors versus employees under federal law.

Federal Tests to Identify Employees and Independent Contractors

The U.S. Department of Labor (DOL) and the U.S. Internal Revenue Service (IRS) both have their own standards for distinguishing independent contractors from employees. It is essential to understand the DOL and IRS independent contractor test to make sure you comply with federal labor laws and federal tax laws.

The DOL Independent Contractor Test

The DOL recently announced it was rescinding its 2021 rule for determining whether a worker is an independent contractor or employee. Instead, the agency is reverting to its pre-2021 standards. Under the “new” test, the DOL considers the following factors:

  • Whether there is the opportunity for profit or loss depending on managerial skill.
  • Investments made by the worker and potential employer, if any.
  • The degree of permanence of the work relationship.
  • The nature and degree of control over the worker’s duties.
  • The extent to which the work performed is an integral part of the potential employee’s business.
  • The degree of skill and initiative involved in the work.

In general, the pre-2021 rule going back into effect should result in more workers being classified as employees. This change is effective March 11, 2024.

Though these guidelines can be helpful when distinguishing employees from contractors, there can be plenty of gray areas. It is best to speak to a lawyer about any uncertainties.

A good example of this distinction is the difference between an in-house information technology (IT) employee and an IT contractor. A business will likely call and pay an IT contractor only when the business has a particular problem to fix. That contractor will likely bring their own diagnostic and repair tools to fix the problem and then leave the business after they resolve the issue. On the other hand, an in-house IT employee will likely have to come to work for the same business every day. That employee will probably use the materials available at work to run diagnostics and address problems while being paid an hourly wage or salary.

The IRS Independent Contractor Test

The IRS test looks at broader characteristics of a worker’s job to determine if they are an employee or a contractor.  The IRS considers the following factors:

  • Behavioral control,
  • Financial control, and
  • Relationship dynamics.

You can break each one of these factors down into smaller parts to get a better idea of what type of status you have with a worker or business.

Behavioral control

If a business answers several or all of the following questions in the negative, their worker is likely an independent contractor:

  • Does the business dictate how, when, or where the worker works?
  • Does the business tell the worker what tools or equipment to use?
  • Does the business direct the hiring practices of the worker?
  • Does the business tell the worker where to buy supplies and services?
  • Does the business train the worker?

In general, employers have the right to direct how and when a worker works. If a business does not direct how a worker works, they have a strong argument that their worker is an independent contractor. However, a business might be an employer even if they don’t instruct the worker on how and when to work but still have the right to make those kinds of demands.

Financial control

Not only do independent contractors have more control over how and when they work, they have more control over the financial benefits and losses that result from their work. A worker is usually an independent contractor if they:

  • Make significant investments in their work,
  • Don’t receive reimbursement for their business expenses,
  • Bring in profits from their work, and
  • Incur losses from their work.

If all of these characteristics are present in a worker’s job, this can mean that they are running their own business. As we noted above, the DOL test often classifies workers with their own businesses as independent contractors.

Relationship dynamics

If other factors are unclear, looking at the nature of the relationship between a worker and a business can help you conclude whether a worker is an independent contractor. Businesses and workers alike should remember that:

  • Independent contractors do not receive work benefits (insurance, paid leave, retirement, etc.) and
  • The language in any work contracts between a business and a worker should give strong clues about what kind of relationship the two intended to have.

Once again, there can be gray areas when drawing conclusions from the working relationship between a business and its worker. It is best to speak to an experienced attorney about how to classify your work relationships.

What Happens When Businesses and Workers Misclassify Their Relationships?

If the DOL and IRS independent contractor tests are ignored or misapplied, misclassification of a worker can result and have negative effects on the worker and the business. If a business improperly classifies an employee as an independent contractor, they could run into trouble under the Fair Labor Standards Act for failing to pay minimum wage and proper overtime. The business could also run into trouble for failing to give the improperly classified employee benefits under the Family and Medical Leave Act. A business that makes this mistake could be subject to civil and criminal penalties.

Businesses must withhold income tax, Medicare taxes, social security tax, and unemployment wages from employee paychecks. Businesses must give employees W-2 statements and independent contractors 1099 forms. If a worker is an independent contractor, they must do the work of withholding income taxes and self-employment taxes from the payments they receive. If workers and businesses have the wrong classification for their relationships, they could be subject to tax penalties, and they could miss certain deductions.

Please note that misclassifications can also hurt workers and businesses under local and state laws and for purposes of workers’ compensation.

We Can Protect Your Hard Work

Whether you are a business owner or a worker, our employment legal issues lawyers at Batson Nolan PLC can help protect and advance your interests. Our Tennessee firm has been in operation for over 150 years, and we have received some of the highest honors in the legal field. We collaborate with our clients to make sure their unique needs are met. We can do the same for you. Do not hesitate to call us or contact us online for help.