How to Determine Worker Classification

How to Determine Worker ClassificationIan Saderholm2024-06-04T14:13:10-05:00

How to Determine Worker Classification

Determining the proper worker classification for your workforce sets you up for a smooth ride. Properly distinguishing between employees and independent contractors takes some analysis, but can be done! In Illinois, we have seen misclassification issues occur most frequently with the Illinois Department of Employment Security (IDES) and the Internal Revenue Service (IRS), so these are the tests we review here. The IDES test is stricter than the IRS test, so we recommend that businesses follow the IDES test when making classification decisions.

Other government agencies and laws have their own tests, including state and federal departments of labor, the Illinois Workers’ Compensation Commission, the Equal Employment Opportunity Commission (EEOC), the Illinois Department of Revenue, and various employment statutes.

Businesses in the construction industry have the Employee Classification Act, which includes its own test and requirements. It is similar to the IDES test, so reviewing the IDES test below is a good place to start (Employee Classification Act, 820 ILCS 185).

Illinois: the IDES and Unemployment Benefits

The Illinois Department of Employment Security (IDES) is the government agency in charge of unemployment benefits. Employers are required to make unemployment insurance contributions for each of their employees.

The IDES is tasked with ensuring all employers make all the required payments into the unemployment system, so they have a strict test to limit independent contractor classification:

“Service performed by an individual for an employing unit, whether or not such individual employs others in connection with the performance of such services, shall be deemed to be employment unless and until it’s proven in any proceeding where such issue is involved that:

Such individual has been and will continue to be free from control or direction over the performance of such services, both under his contract of service and in fact; and
Such service is either outside the usual course of the business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and
Such individual is engaged in an independently established trade, occupation, profession, or business.” (Illinois Unemployment Insurance Act, Section 212)

Note that the burden is on the employer to prove ALL THREE parts of the test. If it’s a gray area, the IDES and the courts will probably decide the worker is an employee (see AFM Messenger Service v. Department of Employment Security).

*Be Careful* From experience, we have found it to be logistically difficult to make a case to the IDES. They have strict deadlines on all correspondence; in most cases, ten (10) days from the date of mailing. This is one reason business owners should check their mail often! If you receive anything unusual from the IDES, we recommend contacting an employment lawyer immediately.

Here’s how each element of the test is analyzed:

Control or Direction

The more control the business has over when, where, and how the worker performs the services, the more likely the worker is an employee. To be properly classified as an independent contractor, the worker generally set their own hours, aren’t given any instruction manuals or training by the business, use their own equipment, etc.

The administrative code gives 25 factors to weigh when determining worker classification (no one factor alone is enough to decide) (56 Ill. Adm. Code §2732.200(g)). These questions include whether the business:

Sets quotas or time requirements for the worker?
Requires the worker to follow a routine or schedule?
Requires the worker to provide timesheets or work a certain number of hours?
Reimburses the worker for expenses or gives the worker supplies?
Engages the worker on a permanent basis or has the right to fire the worker?
Sets the price for the workers’ services?

Answering YES to any of these indicates more direction and control, while NO indicates less direction and control. If most answers are YES, the worker is probably an employee.

This is the most generally known element of the independent contractor test. Remember that even if this element is met and the worker has control and direction over his or her work, the following two elements must also be met for proper independent contractor classification.

Usual Course of Services

The first criterion of this element is the most important: whether the services are necessary to the business of the company or merely incidental. For example, movers are necessary to a moving company, chauffeurs to a dispatch service, and drivers to a package delivery service (see EZ Movers, Inc. v. Rowell; O’Hare-Midway Limousine Service, Inc. v. Baker; United Delivery Service, Ltd. v. Didrickson). If the worker’s labor is necessary to the business of the company, the worker is almost certainly an employee.

The second criterion, “outside of all the places of business of the company for which that type of service is performed,” rarely comes into play. The IDES and courts interpret “places of business” so broadly that it is almost impossible to meet this criterion. For example, the homes of typists working at home are counted as “places of business” for the employer (56 Ill. Adm. Code §2732.200(f)). Delivery personnel and salesmen aren’t “outside all places of business in which that service is performed” because the workers “represent [the employer’s] interest” everywhere they go (see CR England v. Department of Employment Security; SC v. Department of Employment Security).

Independently Established Trade, Occupation, Profession, or Business

Another important consideration in worker classification is whether the worker has such economic independence that their work could survive any relationship with the person contracting for services. Essentially, would ending the company’s relationship with the worker prevent the worker from continuing their business? The code lists 13 factors to weigh (56 Ill. Adm. Code §2732.200(e)), some examples include:

Is the worker’s business likely to close upon severance of the relationship?
Does the worker have a chance for profits and losses in their business?
Does the worker regularly work or offer to work for other companies?
Does the worker have a business name/office/employees?
Does the worker market their services to the public?
If a license is required, does the worker obtain/pay for its own license? Does the worker buy its own tools/machinery?

Answering NO to any of these indicates that the worker does not have an independent business, while YES indicates the opposite (supporting the case for independent contractor status). If most answers are NO, the worker is probably an employee.

Federal: the IRS

The Internal Revenue Service (IRS) test also considers three categories of factors in determining worker classification for tax purposes, although they are slightly different than the IDES. These factors are:

“Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? [e.g. Does the worker receive company training or have to follow company policies? Does the company set the worker’s hours?]
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like [whether the worker paid on a set schedule], whether expenses are reimbursed, [does the business] provides tools/supplies, etc.)
Type of relationship: Are there written contracts or employee type benefits (that is, pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?” (IRS)

The IRS test is more of a balance test than the IDES test. Answering YES to any of the above indicates more direction and control, while NO indicates less direction and control, so more “YES” responses would indicate an employee relationship.

Federal: the US Department of Labor

As a quick note, the US Department of Labor recently issued a new rule reinstating what it calls “The Economic Reality Test” for the Fair Labor Standards Act. The overall analysis is similar to the IRS test, broken into:

opportunity for profit or loss depending on managerial skill [e.g. whether the worker sets/meaningfully negotiates their pay, whether the worker can decline jobs/timelines, and whether the worker can hire others, purchase materials, and so on];
Investments by the worker and the potential employer [e.g. office space, computers, continuing education costs];
Degree of permanence of the work relationship;
Nature and degree of control;
Extent to which the work performed is an integral part of the potential employer’s business; and
Skill and initiative [a worker that receives training and does not use specialized skills is more likely to be classified as an employee].” (89 FR 1638)

This test is a balancing test, and all of the above factors are weighed together to determine whether the worker could be classified as an independent contractor.

Independent Contractor Classification: When is it Appropriate?

There are situations when independent contractor status is appropriate. In general, this is when your business hires another business to perform services that are outside the scope of what your business does. The hiring business should not control or direct the work. For example, hiring one of the following if your business does not offer these services:

Hiring a website developer to build a website for your business.
Hiring a cleaning service to clean your office.
Hiring a consulting company to train your sales team.
Hiring a graphic designer to create your logo.
Hiring a photographer to get headshots of your team.
Hiring a law firm to serve as outside general counsel for your business [wink].

The relationship is that of a business contracting with another business to provide discrete services. The parties should absolutely have a written contract between them laying out the terms of the services to be provided. We highly recommend retaining a lawyer to draft these contracts.