Proper Independent Contractor Classification: The Legal Ramifications
Texas Builder Magazine of the Texas Association of Builders
8/23/2013
by Leslie L. Hunt
Most individuals in the construction industry know someone who has been the target of a wage and hour investigation. One of the common issues evaluated during this type of investigation is whether a company’s “independent contractors” have been properly classified. In other words, can the company prove that its “independent contractors” should not be treated as an employee?
Whether a worker who performs services for another person is an employee or an independent contractor is not always easy to determine. The proper classification is important, however, because the distinction between employee and independent contractor affects legal rights and obligations, including liability for employment taxes, the right to workers’ compensation benefits, the employer’s potential liability for a workers’ tortious acts, and wage rights such as minimum wage and overtime. Anyone who performs work for a company is presumed to be an employee by the Texas Workforce Commission, the Department of Labor and the Internal Revenue Service (“IRS”). This means a company bears the burden of rebutting this presumption and convincing the governing authorities that a worker is an independent contractor.
Generally speaking, if a company has the right to control what will be done by a worker and how it will be done, an employer-employee relationship exists giving rise to, among other things, wage reporting and tax responsibility. An independent contractor, on the other hand, is self-employed, bears responsibility for his or her own taxes and expenses and is not subject to an employer’s direction and control. Many companies erroneously believe that so long as you give someone a 1099 and call them an independent contractor, that they are properly classified as an independent contractor. However, this is not the way governing authorities view it. Whether a worker is an independent contractor or an employee depends upon much more than what the parties agree to call themselves. It depends on a thorough analysis of the relationship between the individual and the company.
The Supreme Court of Texas has written that the test to determine whether a worker is an employee or an independent contractor is whether the company has the right to control the progress, details and methods of operations of the individual’s work. The company must control not merely the end sought to be accomplished, but also the means and details of its accomplishment as well. Examples given by the Court regarding the type of control normally exercised by an employer include when and where to begin and stop work, the regularity of hours, the amount of time spent on particular aspects of the work, the tools and appliances used to perform the work, and the physical method or manner of accomplishing the end result.[1]
In order for an independent contractor to be properly classified, he/she must truly be independent; therefore, a business must focus on the degree of control versus the degree of independence when determining how to classify a worker. Analyzing the following factors will increase the likelihood of making an accurate determination: (1) instructions given to the worker; (2) training given to the worker; (3) the extent to which the services rendered are an integral part of the principal’s business; (4) any requirement that the services by the worker be rendered personally; (5) the worker’s ability to hire, supervise, and pay assistants; (6) the continuity or permanency of the relationship between the employer and the worker; (7) whether the employer sets hours of work; (8) a requirement to work full-time; (9) the location of the work (on the employer’s premises or at the worker’s home/elsewhere); (10) setting the order or sequence of work; (11) requiring oral or written reports; (12) paying the worker by the hour, week, or month; (13) the payment of the worker’s expenses (business and/or traveling); (14) providing the worker’s tools and materials; (15) significant investment by the worker; (16) the worker’s opportunities for profit or loss; (17) working for more than one business at a time; (18) availability of the worker’s services to the general public; (19) the firm’s ability to discharge the worker; (20) the worker’s right to terminate the relationship; and (21) the amount of the worker’s investment in facilities and equipment.
Governing authorities’ claim that no one factor listed above is weighted a particular way and that there is no magic formula for determining how to classify a worker. In other words, this is a gray area and even a thoughtful analysis offers no guarantees. In cases where businesses want reassurance, the IRS has a Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding that can be filed requesting that the IRS review certain facts and circumstances and officially determine a worker’s status. Although it can take at least six months to receive a determination, it is a step that could prove beneficial, especially for businesses that frequently hire the same types of workers to perform particular services.
In the past, it was common for a business to receive notice of an investigation through written correspondence from a governing agency. Today, however, more and more investigators, especially those working for the Department of Labor (“DOL”), are showing up at jobsites unannounced, and requesting to conduct immediate reviews of business records. The information requested during a surprise DOL investigation is likely to be the same as the information requested through a more traditional notice of investigation received through the mail.
If a DOL investigator shows up at your worksite, you can expect to be asked to provide the following items: (1) names, addresses and telephone numbers of all business owners and company officers (e.g. President, Treasurer, Secretary, Board of Directors and other Corporate Officers) along with a company organization chart if one exists; (2) legal name of the company and all other names used by the company (e.g., “Doing Business As” names); (3) records demonstrating your gross annual dollar volume of sales for the past three years; (4) a list of all employees with their address, hourly rate or salary, descriptive job title, shift and whether you consider that employee exempt from overtime for all current and former employees for the investigative period; (5) payroll and time records for the investigative period, including a copy of the last two payroll completed and time records; (6) birth dates for all employees under age 18 who have performed work during the past 24 months; (7) 1099 forms and contract documents with any independent contractors, subcontractors or day laborers; and (8) federal employer identification number.
One of the best ways to prepare your business for a worker classification investigation is to maintain organized records and be able to demonstrate a good faith, reasonable basis for classifying a worker as an independent contractor. Businesses that demonstrate a reasonable basis for its classifications may be relieved from certain monetary consequences depending on which governing authority oversees the investigation.
The IRS recently added an optional program called the Voluntary Classification Settlement Program (VCSP) intended to encourage voluntary compliance with worker classification rules. The VCSP permits employers to prospectively reclassify workers as employees in exchange for limited federal employment tax liability, no interest or penalties, and without an IRS audit or administrative correction procedure.[2] This is something to consider for businesses that become aware that they are currently treating a class of workers as independent contractors but want to voluntarily reclassify the workers as employees going forward.
I am often asked whether it is a good idea for businesses to have contractual agreements with workers designating them as independent contractors. The answer to that question is an unequivocal yes. Using a contract that clearly sets forth the worker’s status as an independent contractor, such as the Texas Association of Builders’ Independent Contractor Base Agreement, can be dispositive of the parties’ relationship, so long as there is no outside evidence contradicting the terms of the contractual provisions. For example, if the contract states the worker will dictate his own hours of performing services, there cannot be evidence that the hours of work were actually controlled by the company. So long as the contractual agreement accurately reflects the independence of the relationship between the company and the worker, it will bolster the likelihood of being able to establish proper classification of the worker as an independent contractor.
Companies can decrease their chances of misclassifying workers in a variety of ways such as (1) routinely reviewing payroll records to determine how many workers are classified as independent contractors and to confirm that a reasonable basis for such classification exists; (2) allowing workers to control the details of a project such as starting and stopping time and the ability to delegate work duties to others individuals under the control of the worker; (3) paying the worker by the project; (4) having worker use his/her own tools or equipment; and (5) avoiding ongoing, continuous relationships with workers.
Companies should strive to maintain a good relationship with their workers. It is important to listen to concerns or questions raised by workers relating to their classification. These questions can often come in the form of questioning whether a worker or class of workers should be receiving overtime pay. If a worker voices concerns over overtime pay, take it seriously and analyze whether that worker is properly classified. If you discover the worker is misclassified and is owed overtime wages, it is advisable to consult with an employment attorney.
Companies should also encourage workers to come discuss any questions or concerns they have about classification or wage issues. Taking this step can prevent a disgruntled worker from filing a complaint with the Texas Workforce Commission or the Department of Labor, which would likely trigger a wage and hour investigation.
Businesses that take a closer look at existing worker classifications and that take proactive steps to comply with state and federal laws are less likely to be found liable for taxes, wages or other damages and penalties down the road.
About the author: Leslie L. Hunt is a shareholder at Decker, Jones, McMackin, McClane, Hall & Bates, P.C. in Fort Worth, Texas. She earned her J.D. from Baylor Law School and her primary practice areas include employment law and business litigation.
Disclaimer: The content of this article is provided for informational purposes only and does not constitute legal advice.
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[1] Thompson v. Travelers Indemnity Co. of Rhode Island, 789 S.W.2d 277, 278 (Tex. 1990).
[2] Certain eligibility requirements apply.
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