Note: This article is a guest post from Dave Berkus. It originally appeared on Berkonomics.com.
Several years ago, I wrote an extensive article on the ten most important tests of a company in classifying a person as an independent contractor. See http://berkonomics.com/?p=662 for that important insight. But things have gotten much more complicated lately, partly because of the Uber, Lyft and other new generation of workers and the best description of their class as “semi–independent.”
But now we have to weigh in with the U.S. Department of Labor definitions as well as the Internal Revenue Service, and try to make sense of the mix. So here goes:
The Department of Labor (in its Fact Sheet #13) lists six classes of test for independent contractors:
- The extent to which the work performed is an integral part of the employer’s business. (If high, then employee.)
- Whether the worker’s managerial skills affect his or her opportunity for profit or loss. (If high, then employee.)
- The relative investments in facilities and equipment by the worker and the employer. (If worker is even remotely high, then independent.)
- The worker’s skill an initiative. (If initiative high and unsupervised, then independent.)
- The permanency of the worker’s relationship with the employer. (If high, then employee.)
- The nature and degree of control by the employer. (If rules are great and control is high, then employee.)
The IRS guidelines cover the same principles, but the IRS combines these into three basic classes to test that relationship and classify the person in question.
- Behavioral control: Does the employer have the right to direct or control how the work is performed through instructions, training or other means? (If yes, then employee.)
- Financial control: Does the business have the right to direct or control the financial and business aspects of the worker’s job? (If yes, then employee.)
- Type of relationship: How does the worker and the business perceive their relationship? (More difficult. If each considers this a contract, there should be documentation, but that would lean toward independent contractor.)
And the IRS has many more tests within this grouping. (See my article referenced at the beginning of this for those.)
The IRS helps a bit by providing form SS–8 which can be submitted to the IRS for a pre–determination of the status of a worker.
This is not a test to be considered lightly. The penalties for misclassification are onerous, and early stage companies usually cannot afford the risk at the very time when they are most vulnerable. One more time: check out the previous article listed above for the ten tests.
And now, think of Uber, Lyft, AirB&B, and all the others that try to teach and enforce consistency, adherence to company rules, management of time, and determination of the quality of the worker’s facility or vehicle or tools. And try to classify the worker using the above questions. It becomes very difficult, and certainly leads to conflict, potential lawsuits, and lack of easy resolution.
No–one said that managing a business is easy. This range of issues just makes it even more difficult. Yet, the risk of betting the farm on a wrong classification of an increasing number of workers is too great to ignore this subject or not to understand its impact upon the business.
About the Author
Dave Berkus is a noted speaker, author and early stage private equity investor. He is acknowledged as one of the most active angel investors in the country, having made and actively participated in over 140 technology investments. He currently manages two angel VC funds (Berkus Technology Ventures, LLC and Kodiak Ventures, L.P.) and is Managing Director of two Tech Coast Angels ACE Funds (TCA). Dave currently serves as chairman of six of his portfolio companies and is the author of several books.
