Are You Correctly Classifying Workers as Independent Contractors?

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It is very important for a company to know whether its workers are employees or independent contractors.  It is also important for the worker to know which classification properly applies to her.  Most statutory protections for workers – such as the wage and hour provisions of the Fair Labor Standards Act, or the anti-discrimination rules in Title VII of the Civil Rights Act, only apply to employees, and do not apply to independent contractors.  Broadly speaking, “employees” are persons whose work is heavily controlled by those for whom they work, such that the one paying the money generally dictates the terms of the relationship.  The employer-employee relationship thus tends to involve a certain inequality of power, such that the worker may require legal protections to prevent the worker from being abused.  Generally, independent contractors are persons who exert a significant measure of control over their work and their working relationship, such that they may be either in business for themselves or have that level of independence.  In theory, independent contractors have more opportunities either to get a fair bargain or to do business with someone else, and thus are less likely to need legal protections.

Mis-classifying an employee as an independent contractor can have consequences.  A company which fails to pay for overtime hours of work, for example, on the assumption that a worker is an independent contractor, may be liable in court for unpaid overtime wages if the court determines that the worker was in fact an employee.  Likewise, companies which believe they are dealing only with independent contractors may fail to make accommodations for a disabled worker, or fail to take reasonable steps to stop sexual harassment of a worker.  If a court finds that the workers in question are employees, and not independent contractors, however, the failure to accommodate a disability, and the failure to protect an employee from harassment, are violations of the law.

For workers in Texas, there are at least three different tests for determining whether a worker is an employee or an independent contractor: the test used by federal Fifth Circuit Court of Appeals, the test used by the Internal Revenue Service, and the test used by the Texas Workforce Commission.  Although the tests vary, all of the tests are designed to measure the level of control or leverage that the one paying for work exerts over the one doing the work.  The greater the control by the one paying for the work, the greater the odds that the worker is an employee.  For more information about how to determine whether a worker is an employee or an independent contractor, click on “read more.”

 

Employment cases in Texas frequently (though not always) end up in federal court, because of the many federal statutes governing employees.  The U.S. Fifth Circuit Court of Appeals presides over U.S. district courts in Texas and its opinions will therefore always be significant to Texas employment law.  The Fifth Circuit has held that “to determine if a worker qualifies as an employee, we focus on whether, as a matter of economic reality, the worker is economically dependent upon the alleged employer or is instead in business for himself.” Hopkins v. Cornerstone of America, 545 F.3d 338, 343 (5th Cir. 2008). The Fifth Circuit considers the following factors:

“(1) the degree of control exercised by the alleged employer;

(2) the extent of the relative investments of the worker and the alleged employer;

(3) the degree to which the worker’s opportunity for profit or loss is determined by the alleged employer;

(4) the skill and initiative required in performing the job; and

(5) the permanency of the relationship.” Id. These factors are not exclusive and “no single factor is determinative.” Id.

In applying the first factor, “the degree of control exercised by the alleged employer,” the courts consider such facts as who controls the worker’s daily schedule, the timing and number of tasks given to the worker, who sets the price of the worker’s services to the customer, and who decides the manner or technique used in performing the work.  An independent contractor may decide, for example, when he or she will show up for work, when a task can be finished and how many tasks to accept per day.  An employee, on the other hand, tends to show up when he is told, leaves only when he is told, and is expected to take however many tasks per day that the one paying for the work decides.

In applying the second factor, “the extent of the relative investments of the worker and the alleged employer,” courts look at who buys the worker’s tools, and who pays for the cost of things like the worker’s training, or his license to do the work.  An independent contractor is more likely to buy his own tools, pay for his own insurance, pay for his own office space, and absorb the cost of maintaining any licenses.  An employee, on the other hand, does not function in the manner of a “business owner” i.e., he provides mainly his labor, and looks to the employer to provide the tools, office space, utilities, etc.

In applying the third factor, “the degree to which the worker’s opportunity for profit and loss is determined by the alleged employer,” the courts consider such facts as whether the worker can improve how much he or she earns by doing the work in a better or more efficient way, and how much the worker controls the cost or the price of services.  Independent contractors tend to be paid by the task, rather than being paid for a set number of hours or a set salary.  However, it is worth noting that all the factors must be considered together, because even workers paid on a task or piece rate basis can be employees where the overall facts show a relationship heavily controlled by the one paying for their work.

In applying the fourth factor, “the skill and initiative required in performing the job,” the courts look at the extent to which the employee must use her or his own judgment in deciding how to do the work.  The greater the skill and judgment or discretion required by the job, the greater the chances that the worker exercises a measure of freedom in choosing how to perform the task.  An employer tells the employee how to do the job; an independent contractor decides for himself how the job needs to be done.

In applying the fifth factor, “the permanency of the relationship,” the courts look at how long the worker tends to serve one person or business.  An independent contractor tends to work for many people at once, because she essentially has “customers” rather than bosses, and is able to take her services to whomever wants to pay for them.  An employee, on the other hand, tends to get most of her work and her money from one source, and is therefore dependent upon, and controlled by, that one employer.

Finally, the Fifth Circuit looks at the “totality of the circumstances” – meaning any other facts which may show the balance of power between the one paying for work and the one working.  The point is not to have an absolutely exclusive checklist, but rather to have common sense and to consider what life is like for the one doing the work.

The test used by the IRS, and the test used by the Texas Workforce Commission are stated differently, but tend to have common elements and themes with the Fifth Circuit’s test.  Below are the links to the tests used by the IRS and the Texas Workforce Commission (TWC), both provided through the TWC’s internet page.

For the test used by the IRS see http://www.twc.state.tx.us/news/efte/appx_d_irs_ic_test.html

For the test used by the TWC see http://www.twc.state.tx.us/news/efte/appx_e_twc_ic_test.html

Lessons to be Learned from the Above Tests

            What all the tests make clear is that the classification of the worker as an employee or independent contractor is not an arbitrary election to be made by checking the preferred box or filling out the correct form.  Unless the one paying for the work has relinquished a lot of control to the worker, and allowed the worker to dictate many of the terms of the relationship, the worker is probably an employee and the employer is stuck with this fact.  There may be important cost or tax savings involved in treating a worker as an independent contractor, but those savings are only worth having if the company can get them honestly.  Mis-classifying an employee as an independent contractor just sets the stage for a costly and unpleasant review by the IRS, the TWC, or a FLSA lawsuit for unpaid overtime and minimum wage on an individual basis or in a class action.

 

 

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