Worker classification (i.e., whether an individual is classified as an “employee” or an “independent contractor”) is an important issue that impacts every business, regardless of industry. Worker classification affects how workers are paid, what taxes may be owed, and whether a business must comply with various employment and labor laws with regard to its workers. Because worker classification is an inherently fact-specific and detailed analysis that can result in significant liability for a business that does not properly classify its workers, businesses are encouraged to consult with legal counsel when making these determinations.
Here we provide background on worker classification and employer obligations, as well as links to federal and state-specific resources, as a resource for our members. This information is based on United States laws and regulations.
The information contained on this page does not constitute legal advice, and Yoga Alliance recommends that members seek the advice of counsel in determining what state laws and regulations may apply to their businesses.
Understanding the Distinctions between Employees and Independent Contractors
Workers must generally be classified as “employees” unless they meet certain requirements to be exempt from the coverage of the United States’ Fair Labor Standards Act and any similar state or local laws. Workers who are classified as employees are entitled to certain benefits and protections depending on applicable law, such as overtime and minimum wage requirements, workers’ compensation insurance, paid sick leave, protection against discrimination, and more. Businesses are required to withhold income tax as well as withhold and pay Social Security and Medicare taxes for their employees.
Independent contractors, on the other hand, are not afforded the same protections under various employment laws and are responsible for paying their own income taxes. Businesses are generally not obligated to withhold income, Social Security, and/or Medicare taxes on their behalf.
Worker classification standards vary but generally hinge on the level of control the business exerts over the worker. The federal and state governments employ various tests to determine the level of control a business must exercise in order to classify a worker as an employee rather than as an independent contractor.
Most notably, California recently passed AB-5, which codifies the ABC Test (defined below) for purposes of unemployment insurance, wage orders of the Industrial Welfare Commission, and the California Labor Code. As a result, California businesses are now held to the below standard in proving workers are independent contractors. Please visit Yoga Alliance’s California AB-5 resources page for more information.
- ABC Test: This test is generally considered to be the most onerous test for businesses trying to prove their workers are independent contractors, as businesses must prove all three of the following elements:
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade.
Though there are many variations of the worker vs. independent contractor test, they generally afford little to no weight to a business’s characterization of the worker and also generally require that the business prove proper classification as an independent contractor.
Employee Benefits and Protections and Employer Obligations
At both the federal and state levels, various laws provide employees with certain benefits and protections and impose requirements on employers. These same obligations are generally not applicable to independent contractors, whose working relationships are generally covered by state contract law.
- Taxes: Employers are generally responsible for payroll taxes and making appropriate withholdings on behalf of employees. Tax liabilities for misclassification are significant and may include criminal penalties.
- Unemployment Insurance: While unemployment insurance is a federally-created program monitored by the DOL, each state administers its own unemployment insurance program and sets its own eligibility requirements. Generally, employees are eligible for unemployment benefits if their separation from employment is through no fault of their own, and they are ready, willing, and able to work. Together with the state unemployment tax systems, the Federal Unemployment Tax Act (FUTA) provides funds to pay these benefits, requiring most employers pay both a federal and state unemployment tax. An employer that misclassifies its employees may be liable for unpaid unemployment taxes, penalties, and interest.
- Workers’ Compensation: Most states require employers to carry workers’ compensation insurance for their employees, which provides benefits to employees for certain on-the-job injuries and occupational illnesses. Under state workers’ compensation laws, misclassifying an employee may result in liability for any unpaid workers’ compensation premiums and other penalties.
- Wage Laws: Employers must comply with all wage laws, including the Fair Labor Standards Act (FLSA), which establishes the federal minimum wage and overtime pay, and any state and local wage and hours laws as well. Many states have passed minimum wage and other laws that far exceed the obligations of the FLSA, and so it is important to consult with legal counsel to ensure compliance with all applicable requirements. Failure to comply with applicable wage laws may result in significant financial liability for employers.
- Anti-Discrimination Laws: Employees are also generally entitled to protection under numerous anti-discrimination laws, such as the Americans with Disabilities Act (ADA), Title VII of the Civil Rights Act (Title VII), the Age Discrimination in Employment Act (ADEA), and the Equal Pay Act (EPA). Discrimination can be an area of significant legal exposure for employers. While the federal Equal Employment Opportunity Commission (EEOC) enforces these federal anti-discrimination laws, many states have passed their own anti-discrimination laws, which may cover additional employers or protected categories.
- Recordkeeping Requirements: Many of the above-mentioned employment statutes contain company recordkeeping requirements for employees. For example, the FLSA imposes specific requirements about records employers must keep for each nonexempt employee, but does not require such records for independent contractors.
- Other: This list is not exhaustive—there are numerous other federal, state, and local laws that impose obligations upon employers to protect and provide benefits to their employees, including the Occupational Safety and Health Act, the Family and Medical Leave Act, and state and local paid sick leave laws. As a result, businesses are urged to consult with legal counsel regarding classification issues and proper treatment of all workers.