Misclassified as an independent contractor: When can you be considered to be self-employed?

Many employees would love to be their own bosses. After all, it is a tempting prospect to manage one’s own working hours and no longer be dependent on the boss’s instructions. The feeling of working directly for yourself also makes it attractive to switch to self-employment. Some, on the other hand, do not opt for self-employment entirely voluntarily, but see it as the only way to get work.

In any case, both groups run the risk of being classed as falsely self-employed. Employers save on social security contributions and are not bound by labor laws if they employ freelancers. If they make use of these advantageous aspects of a working relationship, but otherwise have the essential characteristics of dependent employment, the legislator classifies these employees as falsely self-employed. But what is false self-employment? How can it be recognized? We answer these questions in the following sections.

What is false self-employment?

False self-employment is not a legal term, but rather comes from colloquial language. In short, it is when a contractor is treated as self-employed but works under conditions similar to those of a permanent employee. This is also known as misclassification of an employee as an independent contractor. This can happen accidentally, but it can also be due to ignorance or unfair intent on the part of the employer.

If it turns out that a free contractual relationship between the client and the contractor is actually in a dependent employment relationship (i.e. essential criteria of false self-employment), then this has legal consequences for both sides – namely …

  • For social security
  • For labor law
  • For taxation

Misclassification as an independent contractor: Who regulates this?

What constitutes dependent employment under labor and social law, i.e. whether there has been a misclassification of a worker, is generally dealt with in the Fair Labor Standards Act(FLSA) and is the purview of the US Department of Labor. The FLSA determines whether an employment relationship is contractual or based on “economic reality” rather than “technical concepts” and is not based on a master servant relationship. The US supreme court has also had a number of rulings, including the decision that there is no single test for deciding whether a person is self-employed or an employee. Instead, it’s the situation or total activity that dictates the classification. Significant factors include:

  1. How integral the services provided are to the principal’s business
  2. Whether the working relationship is permanent
  3. The amount the contractor has invested in facilities and equipment
  4. How much control the principal retains
  5. The contractor’s opportunities for profit and loss
  6. The degree of independent business organization and operation
  7. The amount of initiative, judgement, or foresight in competition with others that the contractor must achieve to be considered successful

If the above mentioned framework conditions apply to an individual, they are not considered to be self-employed or a contractor, but bound by an employment contract and subsequently, an employee. However, the tolerated degree of this independence depends on the activity concerned – and only an overall view of all circumstances should clarify whether an employment contract exists. It is particularly important in this context that the nature and performance of the work and the dependence on the client are essential criteria by which the employment relationship is assessed. The existence of a contract formulated in writing is therefore less important than the actual working conditions for establishing the misclassification of an employee!

Effects pertaining to labor law

The relationship between an employer and its employees is governed by labor law. This law sets out the employee’s dependence on the employer in clear rules. In comparison, independent contractors and freelancers can organize their working relationships much more freely. However, if the independent contractor is largely dependent on the client to the same extent as a regular employee, then a misclassification as an independent contractor has occurred. According to labor law, if they fulfil the criteria listed in the previous section, then an employment contract actually exists, along with all legal consequences. This could mean concrete vacation requirements, dismissal protections, wage continuation guarantees in case of illness, and many other advantages for the contractor, depending on the labor laws in their state.

Whether you are being misclassified as an independent contractor under labor law and are entitled to an employment contract may be clarified by bringing a suit to the labor court.

What happens to my taxes when I am misclassified as an independent contractor?

In the US, employees are subject to federal and (sometimes) state taxes which employers are required to pay on behalf of their employees, and which must be paid by independent contractors themselves in annual filings. If you are being led to believe that you are a full employee when you are being misclassified as an independent contractor, your employer is not withholding these taxes from your wages and paying them on your behalf, which means you are not contributing to these taxes and may be accused of tax avoidance unwittingly.

Who could be affected by misclassification as an independent contractor?

Theoretically, any self-employment field could have individuals finding themselves misclassified as self-employed. However, in certain occupational groups this exploitation occurs more frequently. These include:

  • Lecturers, professors, and teachers
  • Drivers for forwarding agencies and courier services
  • Honorary doctors and nursing staff
  • Computer programmers
  • Graphic designers, copywriters, and other creative professions

What criteria points to misclassification as an independent contractor?

What criteria should you pay particular attention to if you are unsure whether you are a full employee or an independent contractor? In principle, there are some typical characteristics, even if much depends on the individual case. You can use the following checklist to see whether you are self-employed and how likely it is that an employment relationship will be classified as such. The following characteristics highlight that you may be falsely self-employed:

  • Activity is carried out on a permanent basis and essentially for just one customer: more than five sixths of the turnover is from a single customer
  • Work is carried out according to instructions and integrated into the client’s organization
  • Prescribed place of work with work equipment provided
  • No personal entrepreneurial action – you do not have the appearance of your own company with letter paper or business cards
  • None of your own employees
  • Permanent employees are also employed by the client for the same task
  • Independent contractors with the same tasks have been made permanent employees by the client

Examples of misclassification as an independent contractor

The following two examples illustrate to what extent the misclassification as self-employed can differ:

  • A self-employed graphic designer receives a new customer. The customer pays better than previous clients do, which is why the designer now handles repeated orders for them. As the client has many orders to place now, the designer works exclusively for them after a few months. In order to facilitate coordination with other departments, the client offers to provide a workstation in their office, including a computer and software. The graphic designer agrees to be available in the office during regular working hours and follow general instructions.
  • A cleaner wishes to return to their post after taking parental leave, but with more flexible working hours. They are offered a job on a freelance basis, which they accept. The company provides them with all the necessary cleaning materials and increasingly integrates them into the company’s work planning. In order to simplify the process, the employer determines in detail when the cleaning work is to be carried out.

What are the consequences of being misclassified as an independent contractor?

Being misclassified as an independent contractor has ramifications for your employment status, as well as your social security, Medicare, and federal and/or state tax payments.

Social security, Medicare, and taxes

Employers are responsible for paying social security, Medicare, and federal and/or state income taxes on behalf of their employees. If an employer misclassifies an employee, they are violating wage, tax, and employment eligibility laws. Doing so can incur fines and/or legal action from the US Department of Labor (DoL), the Internal Revenue System (IRS), as well as state agencies. Employers are also required to file payroll taxes and may be fined for failing to do so if they are misclassifying employees.

Additionally, employers must have I-9 forms on record for each individual employee to provide their employment eligibility. If you have misclassified an employee as an independent contractor, you may be fined for not retaining their I-9 forms on record.

Failure to pay for any fines or employee back-taxes, as well as being found to be deliberately misclassifying employees, may result in criminal or civil proceedings.

Labor law consequences

Aside from financial losses at the hands of the DoL, IRS, or state agencies for misclassifying employees, employers also open themselves up to the possibility of class-action lawsuits being brought against them by their employees. These can be lengthy and extremely expensive, as well as contribute to reputation damage and the loss of potential talent.

Click here for important legal disclaimers.


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