This article originally was published in the North Carolina Employment Law Letter.

On August 11, 2017, the North Carolina Employee Fair Classification Act (EFCA) was signed into law. The new law, which will take effect on December 31, 2017, provides a mechanism that allows workers to more easily report—and state agencies to more easily prosecute—employers misclassifying workers as independent contractors instead of employees. Given the increased potential impact of worker misclassification under the new law (including higher legal expenses and other costs), North Carolina employers should confirm that workers are correctly classified and resolve any issues before the December 31 effective date.

Misclassification defined

Worker misclassification remains a hot topic for employers and a priority for federal and state agencies. Workers who are classified as employees are provided certain protections under the law regarding issues like minimum wage, overtime pay, benefits, equal employment opportunities, and on-the-job injuries. Those protections do not apply if a worker is an independent contractor. In addition, employers must pay certain state and federal taxes for employees, but not for contractors.

Fundamentally, workers who are classified as independent contractors are considered separate and independent of the employer in the eyes of the law. As a result, contractors are not provided the same legal protections as employees, and employers do not have to pay employment or payroll taxes for contractors. Over the last 10 years, state and federal agencies have become much more aggressive in investigating worker misclassification and seeking to recover unpaid taxes and wages.

Summary of the EFCA

The EFCA establishes a new division of the North Carolina Industrial Commission called the Employee Classification Section (ECS). The ECS will investigate reports of worker misclassification and assist other state agencies, including the Industrial Commission, the North Carolina Department of Labor (NCDOL), and the North Carolina Department of Revenue, in recovering moneys owed as a result of misclassification. The ECS will also assist state agencies and district attorneys’ offices in prosecuting employers that fail to pay penalties assessed as a result of worker misclassification.

Notably, the new statute does not change the definitions of “employee” or “independent contractor” under North Carolina law; it simply provides an enforcement mechanism for the current law. The law’s practical effect, which cannot be understated, is that a single misclassification complaint could trigger a full-fledged, multi-prong investigation into an employer’s classification of all workers.

However, the new law does not stop there in its effort to curb misclassification of workers. It requires employers to post a workplace notice informing workers that they should be classified as employees unless they are independent contractors and that workers who believe they have been incorrectly classified have the right to report potential misclassification to the ECS. Additionally, licensure applicants before state licensing boards must certify that they have read and understand the ECS's public notice statement defining employee misclassification and disclose any investigations into misclassification, including the outcome of the investigations. Applicants that fail to comply with those requirements will have their license, permit, or certification application denied.

Which Is It? Employee or Independent Contractor?

The EFCA applies to the misclassification of workers under multiple areas of the law, including wage and hour law, workers' compensation law, and tax law. Because different tests for determining employee and independent contractor status are applied under different areas of the law, a worker's correct classification depends on the legal context. The analysis is always a case-by-case determination and typically turns on control—i.e., whether the worker is truly an independent agent who controls her own work (an independent contractor) or whether the worker's service is controlled and directed by the employer (an employee).

For many years, the IRS utilized a list of 20 factors for employers to consider when determining workers’ status for tax-related purposes, commonly referred to as the “20-factor test.” In recent years, the IRS has sought to simplify the test by using a three-category analysis: (1) behavioral control, (2) financial control, and (3) the relationship of the parties. Because the 20-factor test is comprehensive, it is still a helpful analytical tool to aid employers in determining where control lies.

When answering the questions, a high number of “yes” responses means the arrangement is more likely an employer-employee relationship, while a high number of “no” responses may indicate an independent contractor relationship. No single answer is more indicative of employee status than others. The questions are:

  1. Instructions. Is the worker required to comply with the employer's instructions about when, where, and how to work?
  2. Training. Does the worker receive required training, including attending meetings and working with experienced employees, from or at the direction of the employer?
  3. Integration. Does the success of the employer’s business significantly depend on the performance of the services the worker provides?
  4. Services rendered personally. Is the worker required to perform the work personally?
  5. Hiring, supervising, and paying assistants. Has the employer hired, supervised, and paid assistants for the worker?
  6. Continuing relationship. Does the worker have a continuing relationship with the employer?
  7. Set work hours. Is the worker required to follow set work hours?
  8. Full-time work. Does the worker work for the employer full-time?
  9. Place of work. Does the worker perform work at the employer's premises and use its office equipment?
  10. Sequence of work. Does the worker follow a set schedule or order in performing the work?
  11. Reporting obligations. Does the worker submit regular written or oral reports to the employer?
  12. Payment by hour, week, or month. Does the worker receive payments of regular amounts at set intervals?
  13. Payment of business or travel expenses. Does the worker receive payment for business and travel expenses?
  14. Furnishing of tools and materials. Does the worker rely on the employer for tools and materials?
  15. Significant investments. Has the employer invested in the facilities or equipment used to perform the work?
  16. Risk of loss. Are payments made to the worker set on a fixed basis regardless of profit or loss?
  17. Working for more than one company at a time. Does the worker work only for one employer at a time?
  18. Availability of services to the general public. Are the services offered to the employer unavailable to the general public?
  19. Right to discharge. Can the worker be fired by the employer?
  20. Right to quit. Can the worker quit at any time without liability?

If you are in doubt, workers should be classified as employees rather than independent contractors. Since a worker's classification as either an employee or an independent contractor is a case-by-case, fact-specific analysis, employers with large numbers of similarly situated employees are encouraged to confer with legal counsel on this issue.