Mastering Worker Classification: Seven Essential Tips for Restaurant Owners

Navigating the bustling world of the restaurant industry comes with its own set of challenges, and one critical area that often flies under the radar is worker classification. Understanding whether your staff are employees or independent contractors isn’t just about following the rules—it’s key to maintaining a fair, compliant and smoothly running establishment. Misclassifying workers can lead to a slew of headaches, from costly fines to tarnished reputations. Here’s a streamlined guide with seven essential tips to help you tackle worker classification like a pro.

Tip #1: Understand Why Worker Classification Matters

Getting worker classification rights is more than just a legal obligation— it’s about optimizing your payroll, ensuring your staff receives the proper benefits and managing your workforce effectively. Worker misclassification occurs when an employer incorrectly labels a worker as an independent contractor rather than an employee or vice versa. Misclassification can lead to a host of legal problems, including fines and penalties. Key considerations include:

Wage and Hour Laws

The Fair Labor Standards Act (FLSA) sets standards for minimum wage, overtime pay and recordkeeping. Employees classified as exempt from overtime must meet specific criteria, such as executive or administrative duties. Misclassifying a worker as exempt when they do not meet these criteria can result in wage disputes.

Benefits and Protections

Full-time employees are often entitled to benefits such as health insurance, paid leave and retirement plans, whereas part-time and temporary employees may not be. Ensuring that each worker’s classification aligns with their benefits and protections is vital for compliance.

Tax Implications

Employees have taxes withheld by their employer, while independent contractors are responsible for their own tax payments. Proper classification affects payroll processing and tax reporting responsibilities.

Tip #2: Understand the Definitions

Employees and independent contractors are distinct categories with different rights and obligations. These distinct categories must be properly determined by business owners. When determining the correct category for a work, an owner should consider the following items:

Employees

Employees work under the employer's control, receive benefits and are subject to payroll taxes. Employees typically have a more structured work schedule, use employer-provided tools and work on tasks defined by the employer.

Independent Contractors

Independent contractors operate their own businesses, control how and when they perform their tasks, and handle their own taxes. Independent contractors usually have greater flexibility, provide their own tools, and are often hired for specific projects or short-term engagements.

Tip #3: Know the Rules

As a restaurant owner, it's crucial to comply with all federal, state and local employment laws to ensure that you provide the highest level of protection for your workers. Worker classification—whether an individual is an employee or an independent contractor—can be influenced by three key tests:

New Department of Labor Test

On January 10, the U.S. Department of Labor (DOL) published a final rule that took effect on March 11, updating its guidance on determining whether a worker is classified as an employee or an independent contractor under the FLSA. This new rule repeals the Independent Contractor Status Under the Fair Labor Standards Act rule (2021 IC Rule) issued on January 7, 2021, and introduces a revised analysis that aligns more closely with the FLSA as interpreted by established judicial precedents.

The final rule uses a totality-of-the-circumstances analysis that considers six factors, giving no individual factor predetermined weight. The factors are:

• Opportunity for profit or loss depending on managerial skill.
• Nature and degree of control.
• Degree of permanence of the work relationship.
• Work performed is an “integral” part of the potential employer’s business.
• Specialized skill and initiative.
• Relative amount of investment of capital or entrepreneurial effort by the worker compared to investment by potential employer.

Internal Revenue Service (IRS) Test

For IRS purposes, whether a worker is an independent contractor or an employee depends on the relationship between the worker and the business. Generally, there are three categories to consider.

• Behavioral control − does the company control or have the right to control what the worker does and how the worker does the job?
• Financial control − does the business direct or control the financial and business aspects of the worker's job?
• Relationship of the parties − are there written contracts or employee-type benefits, such as a pension plan, insurance or vacation pay? Will the relationship continue, and is the work performed a key aspect of the business?

ABC Test

Some states, such as California, Illinois, Massachusetts, New Hampshire and New Jersey, utilize the “ABC test” to determine whether a worker is an independent contractor or an employee. Under the ABC test, a worker may be classified as an independent contractor only if all three of the test’s criteria are satisfied:

• The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
• The worker performs work that is outside the usual course of the hiring entity’s business.
• The worker is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed.

Tip #4: Understand the Risks of Misclassification

Misclassification impacts various aspects of the employment relationship, including wages, benefits, taxes and legal protections. Misclassifying workers can have significant repercussions, including:

• Legal penalties: Employers may face fines, back taxes and legal actions if workers are incorrectly classified.
• Financial implications: Misclassified employees may claim unpaid wages, benefits or damages, impacting employer finances.
• Reputational damage: Misclassification issues can harm a company’s reputation and employee morale.
• Increased scrutiny and audits: Misclassification issues can trigger audits and increased scrutiny from regulatory agencies. This not only puts the company under the microscope but also diverts resources and attention away from core business activities.

Tip #5: Document Everything

Maintaining comprehensive documentation can protect your business from potential disputes. Keep detailed records of:

• Contracts: Clearly outline the nature of the relationship, including responsibilities, payment terms and project duration.
• Work assignments: Document the tasks and how they align with the worker’s status as an independent contractor or employee.
• Communication: Record key communications that demonstrate the worker’s level of control and independence.

Tip #6: Promptly Correct any Worker Classification Errors

If you discover a worker classification error, addressing it promptly and proactively can save you money. A cost saving for worker classification correction is showcased in the IRS Voluntary Classification Settlement Program (VCSP). Here’s what you need to know:

• VCSP is an optional program: This program provides businesses with an opportunity to reclassify their workers as employees for future employment tax purposes with partial relief from federal employment taxes.
• VCSP requirements: Businesses must meet certain eligibility requirements and apply by filing Form 8952, Application for Voluntary Classification Settlement Program (VCSP), and enter into a closing agreement with the IRS.
• VCSP advantages: In exchange for agreeing to prospectively treat the class or classes of workers as employees for future tax periods, the taxpayer will:
• • Pay 10 percent of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year. See VCSP FAQ 15 for information on how payment under the VCSP is calculated. Also see Instructions to Form 8952.
• • Not be liable for any interest and penalties on the amount.
• • Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years.

Tip #7: Know When to Seek Experienced Legal and Tax Advice

Since misclassification can lead to significant legal and financial repercussions, understanding when to consult a legal professional can make a substantial difference. Consider consulting with a legal expert when:

• Laws are complex. Worker classification laws can be complex and vary by jurisdiction. Legal professionals can offer clarity and advice based on the latest legal standards and case law.
• Taking preventive measures. Proactively seeking legal advice can help you avoid issues before they arise. This is especially true for businesses that want to ensure their practices align with legal requirements.
• Entering into employment agreements. If you're drafting or revising contracts and need to ensure that classification terms are clear and legally sound, consulting with a legal professional can help you create documents that reflect the correct status and obligations.Addressing disputes and claims. If former or current workers are challenging their classifications or filing claims related to misclassification, a lawyer can help manage these disputes and develop strategies to address them.
• Facing an audit or investigation. If your business is subject to an audit or investigation by the IRS or labor agencies regarding worker classification, it’s crucial to have legal representation to navigate the complexities and protect your interests.

Worker classification is a crucial aspect of running a successful restaurant. It affects everything from taxation to benefits to worker rights. By staying informed, addressing mistakes promptly and seeking legal advice when needed, you can avoid costly pitfalls and maintain a compliant, efficient and fair workplace.