Do you have any workers that you classify as an "independent contractor"? Many construction employers do. But they often make this decision without first evaluating the legal test for contractor status. Employers often believe that if they simply agree to a contractor relationship, the law will honor that agreement. In fact, intent is only one of many factors that define contractor status.
The Fair Labor Standards Act (“FLSA”) regulates wage and hour matters, such as overtime and minimum wage, for employers throughout the country. The FLSA, however, applies only to employees. The Department of Labor (DOL) enforces the FLSA. DOL has adopted an “economic realities” test to determine contractor status. The test focuses on monetary risk. A worker that risks losing money on a job is typically a contractor. The money paid to a contractor is directly related to the end result. But a worker who receives the same amount regardless of result, or who receives payment based on time worked, is probably an employee.
DOL considers other factors relevant to the economic realities test: (1) whether the employer controls performance, including hiring, firing, and discipline; (2) whether wages are paid to the worker; (3) whether the worker invests in equipment; (4) the permanency of the relationship; (5) the skill required; and (6) whether the work is integral to the business. No one factor controls; all must be considered together.
In addition, DOL looks to whether the worker completes tax forms and is on payroll with deductions, whether the employer keeps books and records for the worker, whether the employer can approve employees of the worker, whether the worker has an economic interest in the work, and whether the worker must work at one location. The DOL does not consider relevant where the work is done, whether a formal work agreement exists, whether the worker is licensed, and whether the worker is paid a set wage as opposed to tips.
In determining control, DOL looks at whether a contract indicates which party controls performance; whether the employer controls the worker’s business; whether the contract is for an indefinite or relatively long period; whether the employer can discharge the contractor’s employees; whether the employer can cancel the contract and if so, with how much notice; and whether the work is similar to that done by employees.
Many employers have unpleasantly discovered, typically through a lawsuit or government audit, that the workers they felt confident were contractors were in fact employees. Penalties for failure to properly classify can be severe. They include penalties related to federal and state income tax withholding (these agencies have their own classification tests, further complicating the analysis), unemployment insurance contributions, workers’ compensation penalties, liability for minimum wages and overtime, and additional liabilities.
In addition, in difficult economic times, government agencies seeking additional revenue tend to be more aggressive in their efforts to find misclassified workers. The California Attorney General recently recovered millions of dollars from building contractors, transportation firms, and cleaning companies that had misclassified workers to evade workers’ compensation requirements. Industries in which classification decisions tend to be made in lockstep fashion are particularly appealing targets.
Consequently, at minimum, employers should (1) familiarize themselves with the legal requirements governing contractor/employee status; (2) conduct an audit of their practices to evaluate their level of compliance; (3) develop written policies on how to classify workers properly; (4) use job descriptions that identify whether a position is contractor or employee, including reasons supporting the classification decision; and (5) train managers so that practices are standardized throughout the company.
Finally, while this article has addressed certain legal requirements under federal law, the laws of each particular state must also be considered.
The potential liabilities relating to improper contractor classification are significant. By taking a hard look at the realities of classification decisions at the inception of work relationships, however, employers can take a significant step toward ensuring compliance in their workforce.
For more information on this subject, contact the Department of Labor website.
