Have You Ever Heard of the Economic Realities Test?

Most small business owners are at least aware that there is a difference between an employee and an independent contractor. Some don’t realize how very important it is that employers be crystal clear about the difference and how they employ people in their business. Here at The Payroll Department, we believe that it is such a critical decision when talking about payroll that employers need to know, and understand the terms used by the government – like the Economic Realities Test.

We won’t take the time to go over the basics again, but you can find them easily on The Payroll Department blog. We have written blogs about how to determine how to best classify a worker, what the consequences for misclassification can be, and the pros and cons of hiring one over the other.

Much of the interpretation comes down to the “independence” a worker has. Most often, an independent contractor is in business for himself. He generally chooses his work and sets when and how to do the work. He is economically “independent.” An employee, on the other hand, is likely to be economically dependent on the employer.

The Economic Realities Test

The federal Department of Labor and the courts use and “economic realities” test to determine into which classification a worker fits. There are six main factors to the test:

1. Is the work integral to the company’s business? If the worker is manufacturing a product or providing an essential service, they are likely to be an employee. Someone cutting the grass, painting the offices, or building out a website is more likely to be an independent contractor.
2. Does the job require special skills or expertise? Independent contractors are often small business owners themselves competing on the open market and possesses knowledge and skills specific to the work they perform.
3. Is there potential for the worker to make a profit (or have a loss)? An independent contractor generally negotiates a price for the work to be completed. Employees are generally paid a wage or hourly rate, which means the worker is paid for whatever time is required to complete a job or task.
4. Who supplies the materials and equipment needed to complete the work? An employee usually has everything needed provided to him. A contractor generally is asked to provide an outcome using the tools, equipment, and supplies available to him.
5. The term of the job. Long-term or open-ended positions or jobs are generally indicative of an employee/employer Independent contractors often work by the project or job and for more than one company at a time.
6. Control over the job. This is really where “independence” comes into play. A contractor is usually provided an outcome or desired result to achieve by a pre-determined date. How and when that outcome is brought to fruition and meets the deadline is up to the contractor. On the other hand, an employee will be told what is to be achieved and how the work is to be completed. The employer provides what is needed in the workplace and has control over an employee, he does not when it comes to the independent contractor.

Are your workers properly classified?

If this information is relatively new to you, you might think it’s no big deal. Just change the worker’s status and move forward. However, the government doesn’t work that way. Non-compliance with labor laws and regulations brings fines, penalties and headaches. It is really important that workers are on your books the right way from the get go. You have enough small business taxes to pay without additional fees.

Here at The Payroll Department we work with our clients to help them determine what classification is best if there are any questions at all. In fact, it’s just this kind of issue – governmental labor laws and regulations – that make many of our clients decide to outsource their payroll processing to us. Of course, we also save lots of time and money, too, and we don’t have to be trained!

The Payroll Department has taken a leadership role in providing payroll services in the central Indiana area over the last two decades and have since expanded beyond the state lines into neighboring states. Our goal is to provide every small business owner with the confidence and peace of mind to put their time and energy into building their businesses, not worrying about labor laws, rules and regulations. Contact us at 317-852-2568 to learn more. Don’t wait until you have a problem (although we’ll still help you!)

-Elaine of The Payroll Department Blog Team