Who is an Independent Contractor?

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with a financial advisor from Massachusetts is representative of a common inquiry involving independent contractors and retirement plan eligibility. “Who is considered an ‘independent contractor,’ and should he or she be included in the retirement plan of the employer who contracts for their services?”

Highlights of the Discussion

• This is a very timely question. On January 6, 2021, the Department of Labor (DOL) issued a final rule clarifying the standard for employee versus independent contractor under the Fair Labor Standards Act (FLSA). The effective date of the final rule is March 8, 2021. Because determining the correct worker status is an important tax question it is advisable to seek the help of a qualified tax professional. What follows is a general explanation of the DOL’s final independent contractor regulations for educational purposes only. 

• Generally, a person who meets the definition of an independent contractor is not an employee of the business for which he or she provides services and, therefore, would not be eligible to participate in the business’s retirement plan. 

• However, an independent contractor could contribute to his or her own retirement plan based on his or her self-employment income.  

• Under the final rules, the DOL will consider a worker to be an employee if he or she is dependent on a particular individual, business, or organization for work. In contrast, the DOL will consider a worker to be an independent contractor if he or she is in business for him- or herself. The determination is based on the “Economic Realities Test,” which has five distinct factors.  

• Of the five factors that make up the Economic Realities Test, the DOL considers the first two as “core factors,” which are the most demonstrative as to whether a worker is economically dependent on someone else’s business or is in business for him- or herself. They are 

1. The nature and degree of control over the work; and 

2. The worker’s opportunity for profit or loss based on initiative and/or investment. 

• Three other factors that may serve as additional guideposts in the analysis, particularly when the two core factors do not point to the same classification, are  

1. The amount of skill required for the work; 

2. The degree of permanence of the working relationship between the worker and the potential employer; and  

3. Whether the work is part of an integrated unit of production. 

• The final rules include examples that help illustrate the five factors. 

• It is important for the business owner to look at the entire relationship with the worker, consider the degree of his/her right to direct and control the worker’s actions and, finally, to document each of the factors the business owner uses to arrive at the determination. 

• The IRS has some helpful online information on determining worker status at Independent Contractor (Self-Employed) or Employee?  Watch for updates as a result of the final rules. 

• As an alternative, the business can ask the IRS to make a formal determination on the worker’s status by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The filing takes at least six months to process. 

Conclusion

Determining whether a worker is an employee or independent contractor for tax purposes as well as retirement plan coverage purposes can be tricky. The DOL has put forth final regulations to help businesses make the determination based on the five factors of the Economic Realities Test.