Worker Classification: Employee or Independent Contractor?

Independent contractors are often utilized in the construction industry due to short-term needs and the many trades associated with construction projects. When a business treats an individual as an independent contractor, it can reduce its costs in several ways:

• it doesn’t pay unemployment taxes or workers’ compensation insurance;
• it doesn’t pay the employer portion of the Federal Insurance Contributions Act tax;
• depending on the state, it can disregard overtime laws for contractors who work more than 40 hours in a workweek;
• it doesn’t have to provide expensive employee benefits like health insurance; and
• it doesn’t have to withhold state and federal income taxes on compensation.

In most instances, contractors are liable for paying their own taxes on income received through these arrangements.
Many workers prefer to work as independent contractors for several reasons, including flexibility of schedules, autonomy and, of course, tax benefits. The flip side is that independent contractors do not receive the benefits that employees receive, including unemployment insurance and workers’ compensation.

The construction industry is, and historically has been, particularly challenged with classifying workers. For instance, a 2000 report by the U.S. Department of Labor found that the construction industry had the highest rate of misclassification in the nation.

Federal and state governments have cracked down on misclassification in formal audits, and plaintiff attorneys are increasingly filing class-action lawsuits against employers in all industries, challenging the classification of many groups of employees, including installers, drivers, sales representatives and others, seeking to prove they are in fact employees entitled to employment benefits.

Government intervention and private litigation are costly

Independent contractor status removes the worker from company payroll, where taxes are automatically withheld. Thus, the federal government has a vested interest in ensuring workers are not misclassified. The Internal Revenue Service and the DOL are – and have been more and more in recent years – cracking down on the misclassification of workers as independent contractors. These agencies have entered into agreements with numerous states to coordinate enforcement efforts. The ultimate goal is to increase compliance and boost tax collection. The DOL claims that it has recovered millions of dollars in back pay over the past few years.

Many states have also implemented their own task forces to sniff out and scrutinize employers that are misclassifying workers. In the past year alone, Colorado created a task force to investigate and combat the misclassification of construction industry employees as independent contractors. Additionally, several states, such as Delaware, New York, Illinois, Maine, Maryland, New Jersey and Pennsylvania, have worker misclassification laws targeted directly at the construction industry.

Governmental action is not the only concern for employers, as they can also be subjected to costly private lawsuits. Some lawsuits that challenge a worker’s employee status are brought by just one claimant; others, however, are brought by many individuals who join their allegations together in a complaint brought as a Fair Labor Standards Act collective action, as a class action under another law, or as both. Of course, not all claims succeed, but all will require employers to spend time and resources defending against the allegations.

Lawsuits arising from the misclassification of workers are prevalent in the construction industry. For example, just this year, the District of Columbia attorney general filed a lawsuit against a Florida-based construction company, alleging 535 workers were misclassified as independent contractors.

If an employer is found to have misclassified its workers, it may be required to pay employees up to three years’ back pay and liquidated damages, as well as various fines, and in some instances, could potentially even face criminal charges. The DOL may also audit an employer’s records and uncover other wage and hour violations. Likewise, state agencies may seek back payments of unemployment insurance and workers’ compensation premiums.

who is an independent contractor?

This may seem like a simple question, but the answer is not always clear. Merely paying a worker with a Form 1099 does not actually mean that worker is an independent contractor. Further, identifying a worker as a contract employee, freelancer, casual worker or independent contractor (or another similar title) does not automatically render a worker an independent contractor. Similarly, executing a written agreement characterizing the relationship as one of an independent contractor does not guarantee that this status will be found to exist.

There is no single test for determining whether a worker is an employee or an independent contractor. Not only do many jurisdictions implement their own tests, which means that it is possible for a worker to be considering an employee in one jurisdiction and an independent contractor in another, but the relevant legal standard also depends upon which law is being applied and in what context. For instance, income tax, workers' compensation, unemployment compensation, equal opportunity, and wage and hour laws and standards all have their own tests to determine whether a worker is or is not an employee.

In general, relevant considerations in determining whether a worker is an independent contractor include:

• whether the worker's schedule is controlled by the employer;
• whether the worker uses entrepreneurial initiative, judgment or foresight;
• whether the worker has any investment in facilities, equipment and supplies;
• whether the worker has opportunities for profit or loss;
• whether the relationship is permanent or temporary and whether it is indefinite or for a specified duration; and
• whether and to what extent the work is an integral part of the employer's business.

In many states that apply a “common law” test, the analysis places particular importance on the control exercised over the worker, including scheduling and assignment of tasks. However, the ultimate determination rests on whether all of the factors, taken together, establish that the worker is economically dependent on the organization for his livelihood and is therefore an employee instead of a contractor.

Because of the current legal climate, construction employers should evaluate whether they can defend classification of certain workers as independent contractors. Conducting self-audits is a cost-efficient way to start. If there is any doubt whether a worker is an independent contractor or employee, the conservative approach would be to classify the worker as an employee, to eliminate the risk of having penalties assessed against the employer.