Key Takeaways

  • Hawaii law applies both state and federal criteria when determining whether a worker is an employee or independent contractor.
  • Misclassification can result in severe financial penalties, tax liabilities, and back pay obligations under Hawaii’s Wage and Hour Laws and federal law.
  • The Hawaii Department of Labor and Industrial Relations (DLIR) uses the “ABC test” to determine contractor status, focusing on independence, service scope, and business activity.
  • A valid independent contractor agreement in Hawaii should clearly define the scope of work, payment structure, and contractor independence to avoid disputes.
  • Hawaii employers must also comply with local workers’ compensation and unemployment insurance requirements, which vary from other states.
  • Businesses can reduce risks by maintaining compliance programs and consulting qualified employment attorneys—such as those found on UpCounsel.

Independent Contractor vs. Employee

Understanding the difference between an independent contractor vs. employee is vital to paying the proper tax rates, and avoiding severe penalties and consequences. Here's everything you need to know about the two.

To many employers who may have never really thought about the issue, there seems little difference between an independent contractor and an employee. The two classifications may well work side by side doing similar or even identical work, after all. However, legally there are important differences.

When the job title doesn't match the legal definition, regardless of the reasons for the title, problems can result. Employment status has an effect on a range of issues from benefits to tax liability and other financial considerations. Those considering accepting an independent contractor job should keep in mind some key differences between the two.

Hawaii’s Independent Contractor Laws and Tests

In Hawaii, determining whether a worker qualifies as an employee or an independent contractor depends primarily on the Hawaii Employment Security Law and interpretations by the Department of Labor and Industrial Relations (DLIR). Hawaii applies the ABC test, which requires that a worker:

  1. A: Is free from control or direction over the performance of services, both under contract and in fact.
  2. B: Performs work outside the usual course of the hiring entity’s business or outside of all its business locations.
  3. C: Is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

If any of these criteria are not met, the worker is considered an employee, not an independent contractor.This classification affects eligibility for unemployment insurance, workers’ compensation, and wage protections under the Hawaii Wage and Hour Law. Hawaii employers found to have misclassified workers can be held liable for back pay, unpaid taxes, and penalties.

What Constitutes an Employee

Employees work for a single employer, at set hours established by the employer. They often (but not always) receive benefits which can include health care and paid time off. They work at the discretion of the employer, and under their direct control. The employer controls what tasks are completed, when, and how. Employees, in return, don't generally make investments or incur costs related to the job and receive a specific net salary after tax and other contributory withholdings.

If an employee is terminated, they may be eligible to get unemployment. If they're hurt on the job, they can receive workers' comp benefits, and the circumstances for termination vary based on whether or not they are in an "at will" state. They're covered by both state and federal wage and hour laws, as well as anti-discrimination and workplace safety rules. Finally, they're entitled to unionize.

What Defines an Independent Contractor

Independent contractors, on the other hand, provide consulting services to as many companies as they like. They set their own hours and pursue their work according to their own methods and approach. They may work out of a private office or their own home. They receive no benefits from their employer, but in turn, receive only minimal oversight and control. They incur many of the costs associated with the job and tend to have very specialized skills.

Independent contractors do not have taxes and contributory withholdings taken out of their paychecks. Rather, they pay self-employment tax at a higher tax rate. They are ineligible for unemployment or workers' compensation and can be let go for any reason at any time, limited only by any contract they've signed. They are paid according to this contract, as well, and aren't entitled to overtime. In general, labor laws including discrimination and safety rules, don't apply, and they're not permitted to form a union.

Key Clauses for an Independent Contractor Agreement in Hawaii

A well-drafted independent contractor agreement in Hawaii should protect both parties and demonstrate compliance with the ABC test. It should include:

  • Scope of Services: Clearly define the type of work and deliverables.
  • Payment Terms: Specify whether payment is per project, milestone, or hourly basis.
  • Control and Independence: Confirm the contractor’s right to determine work methods, schedules, and tools.
  • Liability and Insurance: Require contractors to carry their own liability or professional insurance.
  • Termination Clause: Outline how either party can end the agreement.
  • Tax Obligations: State that the contractor is responsible for self-employment taxes and will receive a Form 1099-NEC.
  • Compliance Statement: Include a clause affirming that the contractor is not an employee and waives entitlement to employee benefits.

This agreement serves as essential evidence in disputes or audits by the DLIR or IRS, showing that both parties intended an independent business relationship.

Determining Which is Which

The IRS, as well as most states, have rules for how to define independent contractors. These rules focus largely on how much control an employer exercises over the services provided. Workers who supply their own tools and equipment, for example, are independent contractors. Workers who can be dismissed at any time, and can choose when to work and when not to, are independent contractors. If the work is essential to the business, on the other hand, it's more likely the worker is an employee.

Many agencies use what is called an "economic realities test" to properly interpret independent contractors and employees as they apply to the Fair Labor Standards Act (FLSA). This test considers how reliant the worker is on the business for which they work. If, for example, they gain the lion's share of salary from the business, they may be considered an employee.

Besides the FLSA, courts tend to consider:

  • the degree of control the employer has over the work
  • the level of loss that each party stands to suffer if the relationship dissolves
  • who pays for materials
  • the skills required
  • the permanence of the position
  • similar factors - of these the "right to control" factor is often the most important

Some employers deliberately misclassify workers to save money — in fact, the DOL estimates that as many as 30 percent of employers engage in this illegal practice. It's a serious problem that costs the government (both Federal and state) billions of dollars in tax revenue.

Misclassification Risks and Penalties in Hawaii

Misclassifying a worker as an independent contractor when they should be classified as an employee can lead to costly consequences under both state and federal law.According to Hawaii’s labor statutes, employers who misclassify workers may face:

  • Civil penalties and fines imposed by the DLIR.
  • Back taxes for Social Security, Medicare, and unemployment contributions.
  • Retroactive benefits, including unpaid overtime and minimum wages.
  • Workers’ compensation liability if an injury occurs and the worker was improperly excluded from coverage.

Hawaii courts have historically taken a strict stance on worker protections. For example, a Hawaii Court of Appeals decision opened opportunities for workers’ compensation subrogation, emphasizing the importance of correct classification and employer insurance coverage.

The federal government has also ramped up enforcement of misclassification nationwide. Businesses that repeatedly misclassify contractors may be targeted for audits or face joint actions by the IRS and U.S. Department of Labor.

Employers should periodically review their independent contractor agreements in Hawaii and ensure that their practices align with current legal standards to avoid these risks.

Frequently Asked Questions

  1. What is the ABC test in Hawaii for independent contractors?
    The ABC test determines if a worker is an independent contractor by examining their independence, type of work, and whether they operate a separate business. All three conditions must be met.
  2. Does an independent contractor in Hawaii need a written agreement?
    Yes. A written independent contractor agreement in Hawaii is highly recommended to define work terms and prove contractor status if the classification is challenged.
  3. What are the penalties for misclassifying workers in Hawaii?
    Penalties may include fines, back pay, unpaid taxes, and potential criminal charges for repeated violations under Hawaii’s labor laws.
  4. Are independent contractors in Hawaii eligible for workers’ compensation?
    No. Independent contractors are generally not covered by workers’ compensation, but they may seek recovery through contractual or subrogation claims in limited cases.
  5. How can employers ensure compliance with Hawaii labor laws?
    Employers can conduct regular audits, maintain updated agreements, and consult an employment attorney familiar with Hawaii’s classification laws. You can find an experienced attorney through UpCounsel for guidance on compliance and contract drafting.

If you need help with independent contractor vs. employer issues, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.