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The distinction between employees and independent contractors continues to be hotly discussed in both business and legal circles – and with good reason. Though the line separating these classifications may not always be clear, the consequences for misclassification can be disastrous, ranging from failure to pay minimum wage, failure to pay employment taxes, carry or provide insurance, and other violations of state and Federal laws and regulations protecting employees. To avoid these and other legal pitfalls, employers must remain mindful of how the law distinguishes between these two classifications and act accordingly.
The typical employment scenario usually involves an individual (the employee) who performs certain services and duties under the direction and control of another individual (the employer) for a wage. An independent contractor, on the other hand, usually will be paid on a job-to-job basis while implementing his or her own methods (with little or no control from the hiring person or entity) on how the work must be performed. Regardless, the distinction between these two classifications is not always so cut and dry. Read on for a discussion on the different tests Michigan courts will use to determine whether or not a worker is considered an employee or an independent contractor, and how employers may avoid potential liability for misclassifying a worker.
The Economic Realities Test
Under Michigan common law, courts will use the “economic reality test” to determine whether an individual is an independent contractor or an employee. Under this test, Michigan courts consider:
- Whether the employer incurs any liability when terminating the relationship at-will (if so, the individual is more likely an independent contractor);
- Whether the performance of the work is a vital part of the employer’s business (if the services of the individual are merely incidental to the actual operation of the employer’s business, the individual is more likely an independent contractor);
- If the worker primarily depends on wages from the employer to pay living expenses (if so, the individual is more likely an independent contractor);
- If the worker furnishes his/her own materials and equipment to perform the work (if so, the individual is more likely an independent contractor);
- If the worker holds himself/herself out to the public as able to perform tasks of a given nature (if so, the individual is more likely an independent contractor);
- If the work is customarily performed by an individual who is an independent contractor; for example, a restaurant hiring an individual to provide the restaurant with plumbing or electrical services (if so, the individual is more likely an independent contractor);
- If the employer exhibits any control over the work of the individual or the individual’s employees, including the manner in which the employer disciplines or engages/discharges the individual or the individual’s employees (the higher degree of control, the more likely the individual is an employee); and
- If the employer exhibits any control over the payment of wages to the individual (again, the higher degree of control, the more likely the individual is an employee).
McKissic v. Bodine, 42 Mich.App. 203, 208 (1972).
Importantly, no one factor controls under the economic reality test, as courts review all of the factors together under the totality of the circumstances. See Chilingirian v. City of Fraser, 194 Mich.App. 65, 69-70 (1992). This test will be applied regardless of how the parties perceived their relationship or whether or not the type of relationship was specified in a contract. Meaning, while a parties’ contract may recite that a worker is an “independent contractor,” ultimately how the parties’ relationship measures under the above factors will determine whether a worker is properly classified as either an employee or an independent contractor.
The IRS’s 20-Factor Test
Another test commonly used by Michigan courts is the Internal Revenue Service’s (“IRS”) 20-Factor Test (learn more here). Under the IRS’s 20-Factor Test, the courts will evaluate 20 different factors, and these 20 Factors are grouped into three (3) different general categories:
- Behavioral Control
Under the Behavioral Control category, courts and the IRS will generally consider how much independence the individual retains over how their work is performed – the more control or discretion the individual retains over how the work is performed, the more likely the individual is properly classified as an independent contractor rather than an employee. In that regard, employers should evaluate 1) the amount of instructions they provide to the individual for how to complete their work, 2) how much training they provide to the individual, and 3) whether they set working hours that the individual must follow.
- Financial Control
Under the Financial Control category, courts and the IRS will generally consider how much control the individual and employer have over how the individual will be paid and how much investment the individual will put into the work being performed – the more control that the individual retains over these financial matters, the more likely the individual is properly classified as an independent contractor. Thus, employers should consider 1) whether the individual will be paid for specific intervals of work (per hour, a flat fee, an annual salary, etc.), 2) whether the employer will furnish the tools and other equipment needed for the job, and 3) whether the employer will reimburse the individual’s expenses for the individual’s services.
- Relationship Factors
Lastly, under the Relationship Factors category, courts and the IRS will consider the different aspects of the relationship between the employer and the individual. If the individual performs services that are not an integral part of the operation and business of the employer, the individual is more likely to be properly classified as an independent contractor. Again, the individual is more likely to be an independent contractor if: 1) the individual is working multiple jobs for unrelated businesses in addition to the services being performed for the employer, 2) the individual holds themselves out as being available to perform services for the general public, and 3) the employer does not retain the right to discharge the individual at will.
It is imperative that employers consider these tests when classifying a worker as an employee or an independent contractor. If an employer willfully acts to misclassify a worker, there are both criminal and civil penalties that they may be subjecting themselves to under the Workers’ Disability Compensation Act in Michigan. An employer may also subject themselves to civil infractions for an unintentional misclassification of a worker, including payment of unpaid unemployment taxes under the Michigan Employment Security Act and civil fines of up to $1,000 (in addition to other damages) under the Workforce Opportunity Wage Act in Michigan. Federal labor and employment laws, such as the National Labor Relations Act (NLRA) and the Fair Labor Standards Act (FLSA), also require employers to take certain actions with respect to their employees, such as paying minimum wage, overtime rates, and recordkeeping. These laws provide potentially severe penalties for violations, which may occur when employers misclassify their employees as independent contractors.
Classification is a Matter of Degree – and Can Vary Depending on the Test Applied
Again, proper classification is entirely dependent on the facts of each working relationship, and a worker may be properly classified as an employee under one test, but an independent contractor under another. Thus, employers must maintain a thorough understanding of the dynamic of their relationship with workers, and how much control they have over the worker’s performance. Doing so, along with having an awareness of the two tests above will mitigate any risk of an employer misclassifying an employee or independent contractor.
Looking Forward – The PRO Act
Lastly, businesses should be aware that pending legislation at the Federal level will, if passed, additionally impact employee/independent contractor classification. In 2021, the House of Representatives passed the bill, H.R. 842, titled the Protecting the Right to Organize (PRO) Act (the “PRO Act”). The PRO Act, as written, codifies the definition of “employee” under NLRA. Importantly, in its definition of an “employee,” the PRO Act adopts the “ABC test” which is a classification test already adopted by the state of California. Specifically, the ABC test presumes that a worker is an employee unless the employer can prove the following:
- The individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of the services and in fact;
- The service is performed outside the usual course of the business of the employer; and
- The individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the services performed.
Protecting the Right to Organize Act of 2021, H.R. 842, 117th Cong. §101(b).
If signed into law, the PRO Act’s “ABC test” would presume that a worker, under the NLRA, is an employee and would require the employer to prove each of the above elements to classify a worker as an independent contractor. This presumption in particular is a significant difference when compared to the two tests above, and employers should be aware of this test, as it would make it more difficult to classify workers as independent contractors. The Senate bill of the PRO Act, S. 420, is currently stalled in the Senate.
For any questions regarding the status/classification of an employee or independent contractor, contact the attorneys at Fahey Schultz Burzych Rhodes PLC.
By James Budreau and Mitchell Zolton
This publication is intended for educational purposes only. This communication highlights specific areas of law and is not legal advice. The reader should consult an attorney to determine how the information applies to any specific situation.
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