Another Trap for Business Owners: Misclassifying Workers

It’s imperative that businesses classify their employees properly for legal (and moral) reasons. Let’s consider the factors that determine whether a worker is an employee or an independent contractor and, if an employee, whether the worker is exempt from pay rate regulations.

W-2 Employee or 1099 Independent Contractor

Government taxing and labor agencies are both concerned that workers are properly classified. The taxing agencies want to receive all the taxes they are entitled to; the labor agencies, that workers receive all the benefits they are entitled to.

There is no bright line that determines whether a worker is a 1099 independent contractor or a W-2 employee. In fact, there is not even one set of guidelines to use in making the determination; the criteria used by the taxing agencies and labor agencies overlap but differ.

The U.S. Department of Labor considers the following:

  • the degree to which the worker in controlled
  • the worker’s investment in facilities and equipment
  • the worker’s opportunity for profit and loss
  • the amount of initiative and judgment, the worker uses
  • the permanency of the relationship
  • whether the work is an integral part of the organization’s activities

The Internal Revenue Service considers these factors:

  • the instructions and training that the organization gives the worker
  • the extent of the worker’s investment and unreimbursed expenses
  • the extent to which the worker is available to others
  • the method of payment
  • the worker’s opportunity for his or her own profit and loss
  • the existence of a written contract
  • the provision of employee-type benefits
  • the permanency of the relationship
  • whether the work is an integral part of the organization’s activities

Not one of these factors is conclusive. Thus, for example, the mere existence of a so-called independent contractor agreement does not mean the worker is an independent contractor.

It’s very much of an oversimplification, but in essence a worker will be deemed a W-2 employee of an organization, if the worker is controlled by the organization, uses the organization’s facilities, and has little discretion in how and when he or she does the work.

Exempt or Non-Exempt

The federal Fair Labor Standards Act requires that employees – but not independent contractors – be paid overtime, unless there are “exempt.”

Certain positions, such as outside salespersons, are exempt by definition. But for the most part, whether a position is exempt or non-exempt depends on (a) the rate of pay, (b) the method of payment and (c) the type of work being performed. A position must satisfy all three criteria to be exempt.

Rate of Pay

To be exempt, an employee must be paid at least $23,600 per year or $455 per week.

Method of Pay

To be exempt, an employee must be paid on a salary basis. Thus, the pay of the employee may not be reduced, if the organization gives him or her insufficient work.

Type of Work

To be exempt, an employee must perform work within a certain delineated set of job duties. These are called “executive,” “professional’ and “administrative.”

Job duties are deemed exempt executive job duties, if:

  1. the employee regularly supervises two or more employees,
  2. the employee’s duties are primarily management, AND
  3. the employee has real input into the job status of other employees.

Job duties of professionals are exempt. This includes lawyers, doctors, teachers, registered nurses and other employees who perform work requiring “advanced knowledge.” Professional work requires specialized education, usually beyond college, although the education may be met by other means.

Exempt administrative job duties are office or non-manual work, which:

  1. is directly related to management or general business operations or customers, AND
  2. involves the exercise of independent judgment and discretion about matters of significance.

Thus, clerical workers are generally not exempt.


If an employer misclassifies an employee as an independent contractor, or misclassifies a non-exempt employee as exempt, the employer may need to pay significant fines and  penalties, and any back taxes for which the employer is liable.

Feel free to reach out, if you have any questions or comments.

Alan N. Walter