Understanding Employee Misclassification vs Proper Classification

by Matthew P. Suzor and Quintin C. Cerione

Understanding Employee Misclassification

Businesses are required to determine whether individuals providing services are employees or independent contractors. The distinction sometimes can be confusing, and employee misclassification can have serious consequences for both workers and employers.

What’s the difference between an employee and an independent contractor?

The Fair Labor Standards Act (FLSA) sets guidelines for detecting misclassification. Generally, one is an independent contractor if the worker is free from control or direction of the services involved, and if the worker is customarily engaged in an independently established trade, occupation, profession or business. If an individual’s services can be controlled by an employer, then they do not qualify as an independent contractor.

The contrary is true for employees. If an employer controls what will be done and how it will be done, then the individual providing the services is an employee. Additionally, if there is an indefinite or continuing relationship between an individual and an employer, then the worker is likely considered an employee. It is important to note that these are general concepts, and the existence or absence of any particular fact does not guarantee a particular classification outcome. To learn more about the distinction between employees and independent contractors, the Department of Labor (“DOL”) and the Internal Revenue Services (“IRS”) offer guidelines to recognizing misclassification.

What tests are commonly used to detect employee misclassification?

Three of the most common checks that are used to evaluate proper classification are the ABC Test, the Economic Realities Test, and the Common Law Test. Classification outcomes can differ based on the governing law and test used. Therefore, it is important to know what test your jurisdiction uses.

The ABC Test, introduced in California from the Dynamex ruling,1 issues three criteria that must be met for an individual to be considered an independent contractor: the worker must be free from the company’s control, perform work outside the company’s usual course of business, and operate their own independent business. If the worker does not meet all three of these conditions, the worker is considered an employee.

The Economic Realities Test, updated by the DOL in 2024, bases its classification assessment on six factors: the worker’s opportunity for profit or loss depending on managerial skill, investments made by both the worker and the employer, the permanence of the work relationship, the nature and degree of control, whether the work performed is integral to the employer’s business, and the skill and initiative of the worker. No single factor can determine the worker’s status, but all of them together should be used to guide the assessment of whether an employment relationship exists under the FLSA.

The IRS uses the Common Law Test, also known as the “Right to Control Test,” taking the following three categories into consideration: the behavior towards the worker, financial arrangement with the worker, and the relationship with the worker. These categories can be useful in determining the worker-business relationship and can provide evidence of the employer’s degree of control and the worker’s independence.

Why does misclassification matter for overtime, benefits, and tax withholding?

Misclassification has a substantial impact on several aspects of one’s work. If an individual is improperly classified as an independent contractor, their employer may withhold overtime pay that is legally mandated for a full-time employee. Independent contractors also don’t have access to a list of benefits – such as the right to unpaid, job-protected family and sick leave and the availability of unemployment insurance – jeopardizing that access for misclassified workers. Moreover, if an employer misclassifies an employee as an independent contractor, the responsibility for payroll taxes falls on the worker. As a result, the employer avoids withholding and paying federal, state, and local taxes (including Social Security and Medicare).

How can workers or companies fix misclassification before it leads to litigation?

There are a number of steps both workers and companies can take to correct misclassification before it leads to litigation. First and foremost, staying informed and up to date on federal and employment law is one of best ways to help detect and avoid employee misclassification. Second, an internal audit allows an employer to proactively review its workforce to identify all misclassified workers. Third, properly training the hiring team is critical for employers to avoid misclassification, as it tackles a frequent source of the issue. Fourth, it may be worth reaching out to counsel – like the services provided by Miller Shah – to determine the correct classification and understand all legal and financial obligations, including potential penalties

How does Miller Shah help misclassified workers?

We at Miller Shah offer a number of services to help misclassified workers pursue compensation and legal remedies. Our misclassification attorneys can help determine whether a worker has been misclassified and take necessary legal action to hold employers accountable. If you suspect you’ve been misclassified, call us for a consultation.