The following is intended to assist SDSU Research Foundation projects and staff in deciding whether to request individuals be engaged to provide services for SDSU Research Foundation as independent contractors or hired as employees.
At the outset, it is important to note that there is significant risk to SDSU Research Foundation in classifying individuals as independent contractors and not employees. If SDSU Research Foundation is wrong in classifying individuals as independent contractors, the risks may include state and federal tax liabilities and penalties, workers’ compensation penalties, unemployment insurance penalties, wage and hour liabilities and penalties, and possible attorney fees and costs. If there is any doubt about whether the person should be classified as an independent contractor, it is better to take the safer and more prudent approach and classify the individual as an employee.
SDSU Research Foundation recommends that all those responsible for engaging independent contractors and consultants be familiar with the guidelines below, which should be read carefully before making a determination as to whether a worker is an employee or an independent contractor.
The risk to SDSU Research Foundation is enhanced by the fact that the determination of whether an individual is an independent contractor or an employee depends on the particular circumstances.
The US Department of Labor’s Division of Wage and Hour is responsible for issuing guidance on the classification of individuals as independent contractors or employees under the Fair Labor Standards Act (FLSA). The guidance emphasizes the broad definition of employment under the FLSA and addresses the application of each of the “economic realities” factors that employers are to consider when determining how to classify a worker.
The guidance notes that the definition of “to suffer or permit to work” is very broad and the economic realities factors should be applied in view of that expansive definition. Specifically, the guidance states that each factor of the economic realities test should be used as a guide to answer the ultimate question of whether the worker is truly an independent business or is economically dependent on the employer.
The following is a list of the economic factors that are considered in determining whether an individual is an independent contractor or an employee:
- Is the Work an Integral Part of the Employer’s Business?
If the work performed by a worker is integral to the business, it is more likely that the worker is economically dependent on the employer. The guidance further notes that work can be integral to a business even if the work is just one component of the business and/or is performed by many workers.
- Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit of Loss?
In considering whether a worker has an opportunity for profit or loss, the focus is whether the worker’s managerial skill can affect his or her loss. A worker in business for him or herself faces the possibility to not only make a profit, but also to experience a loss.
- How Does the Worker’s Relative Investment Compare to the Employer’s Investments?
The worker should make some investment (and therefore undertake at least some risk for a loss) in order for there to be an indication that he or she is an independent business. The investment of a true independent contractor might, for example, further the business’ capacity to expand, reduce its cost structure, or extend the reach of the independent contractor’s market.
- Does the Work Performed Require Special Skill and Initiative?
A worker’s business skills, judgment, and initiative, not his or her technical skills, will aid in determining whether the worker is economically independent.
- Is the Relationship Between the Worker and the Employer Permanent or Indefinite?
Permanency or indefiniteness in the worker’s relationship with the employer suggests that the worker is an employee. Even if the working relationship lasts weeks or months instead of years, there is likely some permanence or indefiniteness to it as compared to an independent contractor, who typically works one project for an employer and does not necessarily work continuously or repeatedly for an employer.
- What is the Nature and Degree of the Employer’s Control?
As with the other economic realities factors, the employer’s control should be analyzed in light of the ultimate determination whether the worker is economically dependent on the employer or truly an independent businessperson.
While no single factor is determinative of whether the relationship is properly classified, the guidance emphasizes that the “control” factor should not play an oversized role in the analysis of whether a worker is an employee or an independent contractor. Ultimately, each of the factors should be considered in light of whether the worker is really in business for himself or herself and thus an independent contractor or is economically dependent on the employer and thus is an employee.
Under State law, the “right to control” and “ABC” tests are determinant. The primary factors considered significant when analyzing the right to control include: evidence of control over the worker’s terms and conditions of employment, right of termination, furnishing of equipment, and method of payment. Under the ABC test, companies defending independent contractor classification are required to show that an individual providing services:
- Is free from the company’s control in performing the services;
- Performs work outside the usual course of the company’s business or outside the company’s place of business; and
- Is engaged in an independently established business.
In addition to the Federal and State tests, the IRS utilizes a 20-factor “common law” test that incorporates the right to control and economic realities test elements. The IRS has indicated that a worker’s status under the common law list is determined by applying relevant facts that fall into three main categories: behavioral control, financial control, and the overall view of the relationship.
- Behavioral Control- These facts show whether there is a right to direct or control how the employee does the work. Even the right to direct and control the work may be enough to find an employment relationship. Employers typically instruct employees in the following areas:
- When and where to do the work
- How the work should be performed
- The acceptable standards of work performance
- What tools or equipment to use and where to purchase them
- Which individual performs various tasks
- What order or sequence to follow in performing the work.
The amount of training that an individual receives from the business also plays a critical role in the analysis. An individual who is trained to perform services in a particular manner is likely to be considered to be an employee. Independent contractors, on the other hand, ordinarily use their own methods and are responsible for obtaining their own specific training.
Even if no instructions are given, sufficient control may exist if the employer has the right to determine how the results are achieved. Although an employer may lack the knowledge to instruct a highly specialized professional, the key consideration is whether the employer has retained the right to control the details of a worker's performance or has given up that right.
- Financial Control - An employer tends to control the business aspects of the worker's job under the following circumstances:
- An employee has no expectation of realizing a profit or loss. An independent contractor can be expected to make a profit or loss.
- An employee is reimbursed for business expenses. Independent contractors are more likely to have non-reimbursed expenses. Fixed ongoing costs that are incurred by the worker regardless of whether work is performed demonstrate that the worker operates an independent business that is subject to profits and losses.
- An employee has no financial investment. An independent contractor often has a significant financial investment in the business he or she operates (although a significant investment is not always necessary for independent contractor status).
- An employee does not make his or her services available to the relevant market. An independent contractor is free to seek out business opportunities and perform work for multiple clients. They also advertise, maintain a visible business location, and are available to work in the relevant market.
- An employee is paid based on the amount of time spent. Employees are generally guaranteed a regular wage amount that is paid on an hourly or weekly basis, even if wages are supplemented by a commission. Independent contractors, however, are usually paid a flat fee to perform or to complete a particular job (although there are some notable exceptions, where independent contractors would typically be paid by the hour).
- An employee is required to personally perform services. If services are required to be performed only by the worker that indicates that the worker is an employee under the direction and control of the business. Independent contractors can substitute another person’s services without approval of the business.
- Overall view of the relationship – In addition to examining the factors that address different types of control, it is also necessary to consider the overall nature of the relationship, including:
- The intent of the parties to create either an employer/employee relationship or a principal/independent contractor relationship, as set forth in a written contract.
- The permanency of the relationship. Engaging a worker for an indefinite period of time as opposed to a specific period of time generally indicates that an employer/employee relationship exists.
- The right to terminate the worker at will. Having the right to terminate a worker at will – i.e., at any time, for any reason, and without notice – strongly suggests the existence of an employer/employee relationship.
- Requirements to attend meetings or prepare reports. Unless the primary purpose of the contract is to attend meetings or prepare reports, these activities normally demonstrate an employee-employer relationship.
- The services performed by the worker are part of the regular business of the project/department. A worker who provides services that are part of the regular business activity of the project/department is more likely to be construed as an employee. Example: if a grant or project has the purpose of counseling high school students, then individuals who are engaged to counsel high school students are probably considered employees and not independent contractors.
- Providing the worker with benefits, such as insurance, a pension plan, vacation pay, or sick pay. Traditionally, only workers with employee status receive benefits.
The National Labor Relations Board has also adopted a test for independent contractor classification and determining whether a worker is an employee. Under the NLRB’s test, 11 factors are evaluated to determine whether an individual is, in fact, rendering services as part of an independent business. The 11 factors are similar to the DOL’s economic reality test and are as follows:
- Extent of control by the employer;
- Whether or not the individual is engaged in a distinct occupation or business;
- Whether the work is usually done under the direction of the employer or by a specialist without supervision;
- Skill required in the occupation;
- Whether the employer or individual supplies instrumentalities, tools, and place of work;
- Length of time for which the individual is employed;
- Method of payment;
- Whether or not the work is part of the regular business of the employer;
- Whether or not the parties believe they are creating an independent contractor relationship;
- Whether the principal is or is not in the business; and
- Whether the evidence tends to show that the individual is, in fact, rendering services as an independent business.
Under no circumstances may SDSU Research Foundation engage a current employee of SDSU, or the SDSU Research Foundation as an independent contractor.
iii. Making the Decision
If after studying all the above-factors you conclude that a worker would be classified as an employee, the next step is to work with your Human Resources Business Partner to complete the hire process.
When there is convincing evidence that the worker should be classified as an independent contractor, please forward a fully completed Independent Contractor Pre-Selection Checklist, a scope of work statement, and an Independent Contractor Disbursement Authorization Request and Agreement form to your SR grant specialist, MC-1934 for approval prior to the performance of the services. Sample signatures of authorized approving representatives must be on file with SDSU Research Foundation and must agree with the signatures on your request. A copy of these forms may be accessed at AP Forms. Due to the increased monitoring of these relationships, SDSU Research Foundation carefully reviews proposed independent contractor agreements prior to approval. Accordingly, SDSU Research Foundation human resources will make the final determination regarding independent contractor status or employee/employer relationship.
Consulting arrangements in excess of $5,000 and/or a specified contract period of greater than three months may require a consultant agreement in addition to the independent contractor form. The SRA grant specialist will work with the PI to determine if a consultant agreement is needed.
If the independent contractor is a nonresident alien, a Foreign National Information form and other documentation is also required. Refer to Section Processing Non-payroll Payments to Nonresident Aliens for addition information regarding payments to nonresident aliens.
iv. Processing the Payment
Upon completion of work, or as determined by the independent contractor agreement, an original invoice is submitted to the SRA grant specialist for approval and then forwarded to accounts payable for processing.
Note: Only individuals, sole proprietors and partnerships should complete an Independent Contractor form. Corporations are not considered independent contractors.
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