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No less an authority than the United States Supreme Court has established a widely-accepted five-part test, known as the "economic reality" test, that helps establish whether a person is an employee or an independent contractor. In United States v. Silk, 331 U.S. 704 (1947), a case dealing with whether an employer owed Social Security taxes on certain workers, the Supreme Court found the following factors important:
the degree of control exercised by the alleged employer;
the extent of the relative investments of the [alleged] employee and employer;
the degree to which the "employee's" opportunity for profit and loss is determined by the "employer";
the skill and initiative required in performing the job; and
the permanency of the relationship.
(quoted from Brock v. Mr. W Fireworks, Inc., 814 F.2d 1042 (5th Cir. 1987)). Brock, one of the leading cases from the Fifth Circuit explaining independent contractor/employee issues, goes on to state that the "focus is whether the employees as a matter of economic reality are dependent upon the business to which they render service". The same case notes further that "it is dependence that indicates employee status...the final and determinative question must be whether the total of the testing establishes the personnel are so dependent upon the business with which they are connected" that they are employees.
This emphasis on dependence and economic reality demands nothing more than a common sense approach. An employee who has nothing to invest in an enterprise beyond the time he puts in and who sells his services to only one "customer", the employer, is economically dependent upon that work. An independent contractor, on the other hand, is not normally dependent upon only one customer, but rather, being in business for herself and with an investment in her own equipment and supplies, has an entire customer base upon which to fall back.
The economic reality test is used by the U.S. Department of Labor and the Social Security Administration and thus is very important for FLSA and Social Security tax purposes. In 2010, DOL issued a notice of proposed rulemaking indicating that it will amend its recordkeeping requirements to require employers to conduct an analysis of any position for which the worker is not counted as an employee, showing that under the economic reality test, the worker is not in the company's employment. In addition, the company will have to show that it informed each such worker of its analysis and of the worker's rights under the FLSA. Employers would be well-advised to visit www.dol.gov/whd/ often to stay up with developments in this area of the law.
A third way of approaching this problem is called the "ABC" test, which is used by almost two thirds of the states (not including Texas) in determining whether workers are employees or independent contractors for state unemployment tax purposes. In order to be considered an independent contractor, a worker must meet three separate criteria (some states require only that two criteria be met):
The worker is free from control or direction in the performance of the work.
The work is done outside the usual course of the company's business and is done off the premises of the business.
The worker is customarily engaged in an independent trade, occupation, profession, or business.
Under Section 401.012 of the Texas Workers' Compensation Act, "'employee' means each person in the service of another under a contract of hire, whether express or implied, or oral or written," and "includes: (1) an employee employed in the usual course and scope of the employer's business ... ." That term does not include "an independent contractor or ... a person whose employment is not in the usual course and scope of the employer's business." In section 406.121(2) of that law, an independent contractor is defined as "a person who contracts to perform work or provide a service for the benefit of another and who ordinarily:
acts as the employer of any employee of the contractor by paying wages, directing activities, and performing other similar functions characteristic of an employer-employee relationship;
is free to determine the manner in which the work or service is performed, including the hours of labor of or method of payment to any employee;
is required to furnish or to have employees, if any, furnish necessary tools, supplies, or materials to perform the work or service; and
possesses the skills required for the specific work or service."
Finally, the Internal Revenue Service uses a so-called "Eleven Factor" test for determining the coverage of various federal employment tax laws. The eleven factors are all based upon the common law, economic reality, and ABC tests and represent their various criteria either reorganized or broken down into more detail.
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