Engaging Employees and OTHERS in the Workplace: How can you achieve this through worker classification?

Tuesday: Return Driven Strategy FROM THE DESK OF MILES EVERSON: Hello, everyone! Welcome to today’s edition of “Return Driven Strategy (RDS)!” As someone in the business and consulting industry for 30+ years now, one of the things I find effective in managing my team is RDS. That’s why every Tuesday, we publish articles about this framework to help you effectively navigate an ever-changing work landscape as a business leader, manager, or worker. Today, let’s talk about a few worker classification tests in the U.S. through the lens of RDS. Read on to know the importance of these categories to both enterprises and individual workers. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

Engaging Employees and OTHERS in the Workplace: How can you achieve this through worker classification? Worker classification is a topic of increasing importance as the independent workforce continues to grow in number not just in the U.S. but also in other parts of the world. Nowadays, workers can be classified as either employees or independent contractors. Understanding the difference between these two categories is important for enterprises. Here’s the thing… The problem arises when a company classifies a worker as an independent contractor when that person should be classified as an employee (or vice versa). By engaging a worker as an independent contractor, that company must ensure the worker is truly qualified to work as an independent contractor according to federal, state, and local laws. When workers are misclassified, it doesn’t matter whether it was done intentionally or unintentionally. Misclassification can lead to decreased tax collection revenue, loss of employee entitlements such as minimum wage and overtime pay, and class action lawsuits from unhappy workers. So, before we dive deeper into our topic, let’s first understand the differences between employees and independent contractors… What You Need to Know About Worker Classification An employee is someone who provides services to his or her employer in exchange for adequate compensation. He or she is on the company’s payroll and receives wages and benefits for following the firm’s guidelines and delivering the necessary outputs. Meanwhile, an independent contractor is someone who has autonomy and flexibility but does not receive some of an employee’s benefits such as health insurance and paid time off. These workers refer to themselves as freelancers, consultants, self-employed professionals, side-giggers, etc. The BIG difference between independent contractors and an employee is that independent contractors are their own business entity. They pay their own taxes, provide their own benefits, and submit invoices for the work they completed. Independent contractors also provide specialized knowledge or skills to a client project or task. They are responsible for how, when, and where they complete the work outlined in their contract. On the other hand, an employee is typically guided by a manager, and receives some level of training for the job. At present, dozens of federal- and state-level tests exist to help businesses determine whether a worker is an independent contractor or an employee, but these tests vary from one another and are open to interpretation. This can be confusing as laws and regulations are in constant flux nowadays. To dig deeper into the tests and guidance surrounding worker classification, let’s look at some of the basic guidelines from the United States Department of Labor (DOL), the Internal Revenue Service (IRS), and individual states. The DOL Independent Contractor Classification In October 2022, the DOL proposed a new rule for classifying workers as employees or independent contractors. The proposed rule changes certain factors that are considered in the economic reality test, which is used to determine if a worker is an employee or independent contractor under the Fair Labor Standards Act (FLSA). The test looks at whether a worker is economically dependent on the employer for work (an employee) or is in business for themselves (an independent contractor). The proposed rule adopts a totality-of-the-circumstances approach that includes 6 factors: Opportunity for profit or loss depending on managerial skill Investments by the worker and the employer Degree of permanence of the work relationship Nature and degree of control Extent to which the work performed is an integral part of the employer’s business Skill and initiative Both the proposed rule and the current rule adopt the economic realities test that was introduced in several Supreme Court cases in the 1940s. Circuit courts have adopted slightly different versions of the test with slightly different emphases. The IRS Common Law Test for Worker Classification To determine if a worker is an independent contractor or an employee in the eyes of the IRS, businesses must weigh common law rules, or facts that provide evidence of the degree of control and independence in the relationship between a worker and a business. These degrees of control fall into 3 categories: Behavioral Control Behavioral control looks at how much say a business has over the work being done and how the work is done. Generally, if a worker is told when, where, and how to do a job, they are generally considered to be an employee. On the other hand, if a worker does not require guidance or training, completes the work as they see fit, and works where and when they like, they are generally considered to be an independent contractor. Financial Control Financial control looks at whether a business has the right to direct or control the financial and business aspects of a worker’s job. For example: It is more likely for independent contractors to incur unreimbursed expenses than employees. Independents will also typically provide their own equipment or tools, whereas employees will rely on their employer to provide what is needed to do the job. Payment is another factor. While employees are paid a regular wage in exchange for working for a specific period of time, independents are typically paid a flat fee for completion of a project. Independents can also incur a profit or loss from a job and are free to market their services to other businesses. Relationship of the Parties A contract that defines the relationship between parties and describes a project to be completed in a specific time period generally indicates the relationship of a business with an independent contractor. On the other hand, if a worker is engaged for an indefinite period of time, provided with benefits such as health insurance, vacation, or overtime pay, or performs services similar to regular business activity, this generally indicates the relationship of a business with an employee. The IRS provides guidelines for employers’ tax liability. Depending on the type of business relationship an employer has with his or her workers, he or she may or may not be responsible for withholding income taxes, withholding and paying Social Security and Medicare taxes, and paying unemployment tax on wages. State Worker Classification Tests Currently, the majority of states in the U.S. have signed a Memorandum of Understanding (MOU) with the Wage and Hour Division (WHD) to protect against misclassification. The MOUs affirm the intent to help provide easy access to employees and employers, share information, and coordinate misclassification investigation efforts. To further combat misclassification, many states also use the “ABC Test,” which has 3 factors that a worker must meet to be considered an independent contractor. While the test is subject to interpretation and clarification state-to-state, it generally consists of the following parts: The worker is free from the employer’s direction or control over the job. The services the worker provides are performed outside of the employer’s usual course and/or place of business. The worker is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the service performed. Individual states may also have different laws regarding independent contractors and unemployment compensation, worker’s compensation, and state tax collection. State-level Departments of Labor provide additional state-specific information on these topics. Worker Classification As Seen Through the Lens of Return Driven Strategy (RDS) In the book, “Driven,” authors Professor Joel Litman and Dr. Mark L. Frigo say building a return-driven organization involves a great deal of business analysis and planning. They explain that in detail through the RDS framework. High-performance firms treat their employees like customers, understanding what services they would like to receive and designing systems that fulfill those needs. Professor Litman and Dr. Frigo discuss that in RDS’ Tenet 9—engage employees and others. “Others” refers to those who may not be employees of the firm but are critical to its success such as independent contractors, vendors, distributors, or other business partners throughout various processes. That’s why firms should also have resources, tools, services, and worker classifications in place for independents and the workforce as a whole. Through these, there will be a strong support system that benefits both businesses and workers in their organizational and individual goals. Determining worker classification remains a complex issue. So, to minimize exposure to misclassification liability, you and your organization should follow federal and state guidelines as closely as possible and use a written contract in all your independent contractor engagements. Also, if you’re looking to gain a better understanding of Return Driven Strategy and Career Driven Strategy, we highly recommend checking out “Driven” by Professor Litman and Dr. Frigo. Click here to get your copy and learn how this framework can help you in your business strategies and ultimately, in ethically maximizing wealth for your firm. Hope you found this week’s insights interesting and helpful.     According to an article in BetterUp, “career coaching” is usually a one-on-one process where a coach helps an employee reach his/her career goals and realize his/her full potential. Learn more about the importance of career coaching in next week’s article!