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State Regulations vs. IRS Rules

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in Compensation and Benefits,Discrimination and Harassment,Hiring,Human Resources

Don’t overlook state laws, which may provide more protection for independent contractors. While the IRS is largely concerned with the issue of who collects and who pays taxes on earnings, states have different interests to protect. Thus, some states may prefer for some contractors to be considered employees under the IRS rule. 

For example, workers’ compensation insurance covers employees injured on the job. If an independent contractor is injured, it may be the state that ends up picking up the tab for medical treatment and rehabilitation. Therefore, it’s in the state’s interest to consider the independent contractor as an employee. The same is true for unemployment compensation.

Check with your state’s labor department to see if stricter rules apply. If that's the case, be sure to structure your independent-contractor relationship to comply.

Generally, those states that set higher standards concentrate on three factors: whether the contractors are free from control over their work, have an off-site place of business and have an independently established business and customers.

Although these criteria seem remarkably simple compared to the IRS’ common-law test, the states require that all three conditions be fully satisfied. To further complicate the issue, IRS standards for employees may differ from those of the Department of Labor. The FLSA defines “employ” to mean “to suffer or permit to work” (29 USC 201 §3 (g)) and defines an employee as “any individual employed by an employer.” The FLSA has a lengthy list of exceptions to this rule but doesn’t specifically exclude independent contractors. Nor does it specifically adopt the IRS’ framework for defining employees. A reclassification of employees by either the DOL or a state agency often leads to an IRS investigation.

When hiring a contractor, you are less likely to be entangled in federal anti-discrimination laws, such as Title VII and the ADA. However, state laws in your area may supersede the federal statutes and extend discrimination protection to contractors. In addition, if your company is a federal contractor or subcontractor, you must comply with most of these laws. 

Caution: States are cracking down on improper misclassifications across the board. To read a state-by-state summary of recently enacted laws on independent contractor misclassification, go to

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