As the economy continues to shift from a culture of full-time employment to an on-demand “gig” marketplace, the landscape of workers’ rights is also changing. Working as an independent contractor rather than an employee allows a worker more flexibility and autonomy in their work schedule, among other things, but that may come at the cost of losing certain benefits. It’s crucial to understand how the legal rights of workers who are considered “employees” are different from those who are considered independent contractors such as consultants, short-term contract workers, and freelancers.
Employment and Labor Law Protections
Although most employment relationships are “at will,” meaning that either the worker or the company can terminate the relationship for any lawful reason or none at all, employees still enjoy certain protections under federal and state laws. State and federal anti-discrimination laws, for example, make it illegal to discipline, terminate, fire, or retaliate against an employee because of certain protected characteristics (including race, gender, religion, national origin, disability, marital status, age, pregnancy, actual or perceived sexual orientation, military status, and veteran status).
Independent contractors enjoy no such protection from discrimination under federal law. Very few states have anti-discrimination laws that define “employee” more broadly than the federal government, so workers who live in such states may qualify for some of these protections even if they are independent contractors.
Wage & Hour Laws
The Wage & Hour Division of the U.S. Department of Labor (DOL), the U.S. Internal Revenue Service, and corresponding state agencies enforce wage, hour, and worker tax laws. For employees, the federal Fair Labor Standards Act and state wage and hour laws dictate the rules regarding minimum wage, overtime pay, mandatory break requirements, earned sick time, family leave, military leave, and more. The DOL conducts investigations, gathers data, and punishes violations of federal employment laws and regulations.
None of these protections cover independent contractors, who must rely only on the terms of the agreement or contract between them and the employer. In the case of a breach of those contract terms, a gig worker would not be able to petition a government agency for assistance in enforcing the contract; rather, they would have to file a lawsuit for breach of contract or breach of promise (promissory estoppel). Since many employers require arbitration agreements in their contracts with independent contractors, going to a court of law may not even be an option when there is a dispute between the worker and the employer.
Tax Withholding and Tax Rate
In most cases, an employer must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to employees. Employers generally do not have to withhold or pay any taxes on payments to independent contractors. Although independent contractors may pay more in up-front taxes (e.g., the “self-employment tax”), they are allowed to deduct numerous business expenses that employees do not have or are not permitted to deduct, which may lower their overall tax burden.
The DOL’s Unemployment Insurance programs provide benefits to eligible workers who become unemployed through no fault of their own and who meet certain other eligibility requirements. These benefits are typically available to employees but not independent contractors, although in most states an independent contractor or employer can choose to pay separately into the state’s unemployment fund for individual coverage.
Workers’ compensation is a state-mandated system of private insurance coverage. Companies pay monthly premiums and make claims for reimbursement to their insurers when covered losses occur. These policies are designed to make sure that employees who get hurt on the job are compensated for their injuries and lost wages. Most states require that businesses carry workers’ compensation coverage for all employees (with certain limited exceptions), but coverage for independent contractors is not required.
Thus, if an independent contractor is injured on the job or suffers a work-related illness, he or she is not automatically compensated, but must file a lawsuit against the employer for losses. Independent workers can purchase standalone workers’ compensation insurance that covers them for all their disparate gigs. Many major insurance carriers offer workers’ compensation policies; in states that have a private rather than state-sponsored market, an independent contractor can purchase workers’ compensation insurance from any private insurance carrier or agency that is licensed by the state insurance division. These costs are borne by the independent contractor, not the employer.
Many companies limit the availability of benefits like health insurance, pensions, 401(k) plans, and perks like free meals and access to recreational and sports facilities to full- or part-time employees. Independent contractors are considered to be their own companies, so they must pay for their own benefits. Under the Affordable Care Act, all individuals are required to maintain health insurance. Workers who are freelancers, consultants, independent contractors, or otherwise self-employed can obtain health insurance through the individual Health Insurance Marketplace. Click here to enroll in health coverage.
Properly Classifying Employees and Independent Contractors
It’s vital for both employers and workers to correctly determine whether a worker is properly classified as an employee or an independent contractor. The IRS uses a “right-to-control” test. Generally, an individual is an independent contractor if the company paying them has the right to control or direct only the result of the work, not what will be done and how it will be done. Each state has different tests to determine whether a worker is an employee or independent contractor for purposes of eligibility in their individual workers’ compensation and unemployment insurance laws. Some of these, like the “economic realities test” used in many states, can make it harder for a worker to qualify as an independent contractor because, in addition to the degree of control test, the test considers how much the worker is economically dependent upon the company. State-specific information is available from state workforce agencies.
What to Do If You’ve Been Misclassified
If you believe you have been misclassified as an independent contractor, you have a few options. You may be able to file a complaint with the Wage & Hour Division of the Department of Labor or your state department of labor to determine your status and recover income or benefits you lost as a result of misclassification. You may also be able to file a private lawsuit for back pay, liquidated damages, attorney’s fees and court costs.