Legal and Regulatory

Independent Contractors in the Construction Industry

One of the primary problems with worker misclassification in the construction industry has been the uneven playing field that makes it difficult for compliant businesses to compete with noncompliant ones.
By Todd Wulffson
July 31, 2018
Topics
Legal and Regulatory

For at least the past decade, there has been a concerted, nationwide movement to limit or even eliminate independent contractor status for workers in the United States. The IRS and state taxing authorities want payroll taxes not paid for contractors along with fewer tax deductions (i.e. more tax revenue) claimed by employees.

The Department of Labor and state wage and hour agencies want to be able to claim the penalties associated with unpaid overtime, missed meal and rest breaks and other violations of labor laws that only employees can bring. Workers’ compensation insurers want a larger labor pool to spread out their risk (independent contractors are not covered by a business’ workers’ compensation insurance). Trial lawyers want to be able to bring class actions for misclassification (which are not covered by insurance), as well as individual actions for harassment, discrimination and wrongful discharge, which only employees can bring.

In fact, the only ones that seem to want more independent contractors are contractors themselves, as well as the businesses that utilize their services. This is especially true in the construction industry, where businesses rely on independent contractors to provide services that are not used in a large enough quantity (or over a sustained period of time) to justify a full-time employment position. The stakes are high: for construction firms, the cost differential (i.e. savings) can be up to 20 percent of an employee's salary. For the government, it could mean the addition of hundreds of millions of dollars in revenues annually in unpaid taxes and fines.

The deck is definitely stacked in the government’s favor. In 2011, the IRS and DOL signed a Memorandum of Understanding to improve information sharing and collaboration to combat worker misclassification. As of 2018, all but nine states have signed this MOU to “protect” employees from being misclassified (and to “protect” state and federal tax revenue). Over the past decade, more than half the states have passed legislation aimed at ending misclassification with harsh punishments for companies who “willfully” misclassify employees. Several states, such as Delaware, New York, Illinois, Maine, Maryland, New Jersey and Pennsylvania have worker misclassification laws targeted directly at the construction industry.

With the federal and state governments investing millions of dollars in audits and investigations, a construction business is at a severe disadvantage already, and can no longer rely on simply “staying off the radar” of entities whose sole purpose is to find that all independent contractors are really employees. Understanding how the law and enforcement procedures are changing around independent contractor classification is therefore as important as minimizing sexual harassment in the age of Harvey Weinstein.

What should businesses and employers do?

  • Hire a professional. With all the focus on the construction industry, even small firms need to retain the services of a competent human resources professional or office manager to ensure compliance. Outside professionals, such as accounting and law firms, can be helpful in determining proper classification, and in setting up systems to maintain compliance over time, but someone within the business ultimately needs to be responsible and accountable.
  • Understand the applicable law. Construction firms, like all employers, must comply with federal as well as applicable state law (basically, whichever law gives the worker more rights becomes the compliance standard). Where the worker lives or where the business is located is irrelevant. The important issue is where the work is performed. California just adopted the “ABC test” used only in New Jersey and Massachusetts, to make all workers presumptively employees under the California Wage Orders (but not the Labor Code), unless the business can prove that all three of the following factors are met:
    • the worker is free from the control and direction of the hiring business in connection with the performance of the work;
    • the worker performs work that is outside the usual course of the hiring entity’s business (this factor actually doesn’t hurt the construction industry much, which is hiring contractors with specific skills that are not engaged in the “business” of construction – but it may severely impact support businesses such as accounting firms, law firms and transportation businesses – because they cannot hire a contractor to engage in the same work as the business itself); and
    • the worker is customarily engaged in an independently established trade, occupation or business.

The rest of the nation uses the “economic realities” test, which focuses on the overall relationship between the contractor and the business, and whether the former is financially dependent on the latter. Although not a complete safe harbor for a construction business, IRS Form SS-8 can be used to request a determination from the IRS on the status of workers, to determine if they are employees or independent. Since the DOL and IRS have their MOU in place, and almost all the states have signed on, compliance with Form SS-8 can at least avoid a finding that there was a “willful” violation, which carries the most severe penalties.

The IRS reviews the SS-8 on a case-by-case basis and issues a determination. A business cannot use this form for a “hypothetical” or proposed situation. A business files Form SS-8 to request a determination of the status of a worker under the “common law rules for purposes of federal employment taxes and income tax withholding.” Generally, under the common law rules, a worker is assumed to be an employee unless the IRS determines otherwise. The IRS researches each request, and may ask for further information. At the end of the process (which might take up to six months), the IRS will either:

• issue a determination letter, which is binding on the IRS; or
• issue an informational letter, which is advisory but not binding.

The DOL has helpful fact sheets on explaining when an employment relationship exists:

• Employment Relationship Under the Fair Labor Standards Act; and
• Get the Facts on Misclassification.

Although not as helpful as a binding determination letter from the IRS, if a business can show it actively complied with the DOL’s criteria, it can expedite an audit and minimize fines. The primary issue under the federal test is whether the business has the right to control how the work is performed. Whether the independent contractor is allowed to take on other work is an issue that, on its own, can disqualify an independent contractor. Typically, employees are given equipment, business cards and regular assignments. Workers are generally considered employees when someone else controls how and when they perform their work. In contrast, independent contractors are generally in business for themselves, obtain customers on their own from their own marketing and control how they perform services. Independent contractors provide their own equipment, and do not get paid time off or other benefits from their clients.

  • Establish consistent, good practices to ensure that workers are classified properly, and that the company can prove it.
  • know the applicable law and document the firm's relationship with an independent contractor;
  • keep all documentation and review it annually to ensure that it is up to date;
  • conduct a self-audit (preferably with counsel so that it is privileged) of all independent contractors if you have more than a few. One of the biggest risks of misclassification is that it can be the basis for a class action lawsuit;
  • make sure all independent contractors have their own business – with their own advertising, insurance, office location and equipment – as well as a customer list that shows the company is not the only employer (another good reason to request and retain references), as well as a valid business license registered with the state;
  • always pay independent contractors through accounts payable, based on invoices received, and never out of payroll; and
  • when in doubt, make the workers employees because the presumption under the law now is that they are.

One of the primary problems with worker misclassification in the construction industry has been the uneven playing field in existence that makes it difficult for compliant businesses to compete with noncompliant ones. However, with the massive effort underway from multiples sources to eradicate misclassification in the construction industry, compliant firms can take solace that they are doing the prudent thing to protect themselves, and that the day of reckoning is here for their less scrupulous competitors.

by Todd Wulffson
Todd R. Wulffson is in the Orange County office of Carothers DiSante & Freudenberger LLP, a leading California employment, labor and business immigration law firm providing litigation defense and counseling to California employers. Wulffson has 25 years of experience counseling and defending businesses in labor and employment issues and has extensive experience representing employers across the entertainment, manufacturing, banking, hospitality, financial services and retail industries. Wulffson focuses on issues related to human resources, and the implementation of proactive measures to reduce risk and cost including substantial experience in the evolving area of Social Media Law. He is a frequent speaker, author and resource to employers nationwide on analyzing employee-related social media issues, preparing social media policies and procedures, and defending actions involving social media liability claims. 

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