When hiring workers, knowing how to classify them can be the difference between profit and disaster.
Of course your employees matter. If they didn't, you wouldn't hire them, trust them to do important work or keep paying them week after week. And if you think about it at all (which you probably don't), you assume they realize that. It's only logical.
Every employer eventually tackles the question of whether its labor force is composed of employees, independent contractors or a combination of both.
The appeal of the independent contractor classification is understandable because the benefits are significant, including the elimination of the need to pay payroll taxes, secure workers' compensation insurance or make unemployment insurance withholdings. Independent contractors also do not receive overtime or double time pay or meal or rest breaks.
Not surprisingly, many employers simply assume an independent contractor classification is defensible and that if it is challenged, a finding that the employee was misclassified will not cause any serious harm. This assumption is misguided.
Misclassifying employees has very serious consequences. A failure to properly classify can subject the employer to administrative enforcement actions, civil penalties, fines, unpaid wages, class action and representative action lawsuits, and the assessment of back taxes and premium payments and related penalties.
Furthermore, misclassification by general contractors could result in discipline in local states such as the California State Contractors' License Board — and may put their license at risk.
Some employers may be tempted to misclassify because they believe the government is unable or unwilling to audit or fine them due to a lack of resources. While this may have been true in the past, in recent years a number of state and federal agencies have begun to aggressively police this issue.
Moreover, because in many states wage and hour laws allow attorneys to recover fees in a private lawsuit filed against employers who misclassified their employees, attorneys are now highly motivated to pursue claims on behalf of independent contractors either on an individual or class basis. When these claims are filed as class actions, they include everyone you have engaged as an independent contractor up to the last four years and can easily bankrupt a company.
Although the consequences of misclassifying can be disastrous, it is possible to both avoid liability and lawfully classify service providers as independent contractors. To do so, the employer must be able to show they satisfy the test for determining an individual is properly classified as an independent contractor.
Passing the Test
There are a number of slightly different tests used by the IRS, the State Courts, the Federal Courts and the US Department of Labor to decide if the service provider is a genuine independent contractor. While the tests are all slightly different they contain three key similarities.
First, all of the tests use a number of factors to determine if someone is an employee or a genuine independent contractor. Second, all of the tests agree the existence of an independent contractor agreement will not, on its own, establish someone is an independent contractor. Third, all of the tests focus on the level of control that the employer has over the employee/independent contractor.
If the employer has a significant level of control over the individual, how they perform the services at issue and treats that individual as their employee, then that individual is most likely an employee. If the independent contractor has a great deal of autonomy and is not subject to the control of the employer, however, then they likely qualify as an independent contractor.
In conducting their tests, the courts and government agencies ask a number of key questions. None of these questions on their own will decide the issue but the answers to each of these questions will tilt the scale in favor of a finding that the individual is an independent contractor or an employee.
Does the employer control how, where and when the person performs the job?
The more control the employer has over the way someone does his or her job, the more likely it is that the person is an employee. For example, if strict guidelines are developed by the employer and extensive training is provided on those guidelines, the person doing the job is more likely to be an employee.
Also, if the employer sets the work schedule and work hours, this will weigh in favor of the employer-employee relationship. Likewise, if the employer controls the location where the work must be performed, this will weigh in favor of the existence of an employee-employer relationship. Specifically, if the service can be provided offsite or from home but the service provider is required to work from the employer's facility, this will be evidence of an employer-employee relationship.
Who provides the tools and materials?
If the employer provides all of the tools and materials and/or pays for all of the tools and materials, then the person performing the service is more likely to be an employee. This includes reimbursement obligations by the employer.
The length of the job?
If the person performing the service is hired for one short project they are likely an independent contractor. If they remain on staff for a long period of time, however, they're more likely to be an employee.
How are they paid?
If the person is paid by the job, they're more likely to be an independent contractor. If the employee is paid by the hour or paid a regular salary, however, they're more likely to be an employee.
Is the service provided the type of service normally provided by the employer?
If the employer normally installs air conditioners and the person they want to classify as an independent contractor is asked to do masonry work, it is more likely this individual is an independent contractor. On the other hand, if the same company brings in another person to help finish an installation of an air conditioner that person is probably going to be found to be an employee.
Is the contractor working elsewhere?
If the person providing the service works full time, or close to full time, for the employer and does not work for other employers they are more likely to be found to be an employee. If that person works for several companies at the same time for just a few hours per week, however, that person is far more likely to be found to be an independent contractor.
Did the parties create a written independent contractor agreement?
If there is a written agreement between the parties stating that an independent contractor relationship exists, this will help establish the existence of an independent contractor relationship. As explained above, however, the fact that the agreement exists, on its own, is not enough to show the service provider is an independent contractor.
Is there mandatory training?
Required training sessions will be evidence of an employer-employee relationship.
Can the independent contractor terminate the job at any time?
An employee is free to quit and walk off a job at any time, and can be fired by the employer at any time. A contractor, however, cannot be terminated at any time without violating the terms of a contract.
Is it possible for the contractor to lose money on the project?
If the project runs longer than anticipated or involves higher material costs than anticipated a contractor can lose money on the project. An employee never has to encounter this problem since they are paid the same regardless of the material or labor costs. Therefore, if the service provider takes on a financial risk by taking the job he/she is more likely to be an independent contractor.
This list of questions is not exhaustive and cannot substitute for the guidance of a skilled employment law attorney. It's a good place to start, however, when examining if your classification of your labor providers are defensible.
Christopher Boman, Esq. is a partner in the Irvine, Calif. office of Fisher & Phillips, a national labor and employment law firm. He can be reached at email@example.com. Boris Sorsher, Esq. is an associate with Fisher & Phillips and can be reached at firstname.lastname@example.org.